In keeping with the theme of previous articles, the next legal entity I will focus on is a general partnership. Similar to sole proprietorships, general partnerships are simple in structure and operation. An obvious differentiating factor, though, is the very nature of a partnership: there is more than one party. As I further proceed in discussing a general partnership, you will note significant overlap with a sole proprietorship, with few, but significant, differences.
A partnership entails a business in which two or more parties own an entity. Importantly, a partnership is not required to be formed by two individuals. It can be formed by individuals, entities, or a combination thereof. Formation of a general partnership requires no formal action or filing with the Secretary of State, except for potentially filing an “Assumed Business Name” as one might do in a sole proprietorship.
The lack of formalities in operating a general partnership may be compelling to some individuals seeking the simplest structure like a sole proprietorship, but it is important to be aware of pitfalls. When you enter a partnership with someone (or multiple someones), there is frequently a level of excitement and perhaps donning of “rose-colored glasses.” Nobody wants to be the pessimist that thinks about the other side of the coin – the “what if.”
What if there is a disagreement among the partners? What if one partner wants to withdraw? What if one partner wants to transfer their interest in the partnership? Whenever there is more than one party, it is advisable to create a formal agreement — a partnership agreement — that outlines how decisions are made, how the entity is managed, and numerous other components of operations. This controlling document, if properly followed, can spare unnecessary conflict and inefficiencies, while potentially preserving an otherwise positive relationship between/among partners.
Taxation is made easy with a general partnership. The general partnership as an entity is not subject to federal income tax. Rather, after the partners determine their respective shares/interest in the general partnership, the income and losses of the entity are taxed on the personal income taxes of the partners in proportion to their shares. This is another “pass-through” entity like the sole proprietorship.
A deterrent to operating as a general partnership is the unlimited personal liability of the partners. There is no legal separation between the partners and the partnership. There is no limit to the liability of the partners. Therefore, if the partnership has any debts or liabilities, they are the responsibility of all partners. As you will find out in future articles, there are forms of partnerships that can limit the liability of a partner, but in a general partnership, no such limitation exists.
If you and a friend or colleague are considering starting a business and think a general partnership is the best option, contact an attorney to guide you through the entity selection process. If you decide to proceed with a general partnership, an attorney can help prepare the partnership agreement that will aid you in operating a successful business.