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	Steven D. Strauss Author of The Small Business Bible
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Partnerships

Description

Unlike other business forms, a partnership must be owned by two or more people. There are two kinds of partnerships: general partnerships and limited partnerships, both of which are reviewed in the following sections. Every partnership must have at least one general partner who is personally responsible for the firm’s debts and liabilities.

General Partnership

In this arrangement, two or more partners enter into an agreement to operate a business. Any general partner may act on behalf of the business unless the partnership agreement says otherwise. It follows that--unless the partnership agreement says otherwise--any of the general partners may, on behalf of the partnership, borrow money, enter into agreements, hire and fire, and execute any other act for the business. So if one general partner grabs the money, maxes out the business line of credit, and then heads to Rio, the other general partners must still pay all outstanding obligations of the partnership, even if it is bankrupt. If protection from personal liability is required, then another structure should be considered.

Limited Partnership

A limited partnership is a general partnership with the addition of outside investors who have limited powers. Not surprisingly, these are the “limited partners.” Unlike a general partnership, a limited partnership cannot be established with a verbal agreement. There must be a written document. For all practical purposes, this should be done by an experienced attorney. The limited partners invest (and often loan) funds to the business, but they are “passive investors” who have no further powers beyond the rights granted in the investment agreements. Limited partners cannot assist in management of the firm nor participate in decision-making. However, they also do not need to worry about unlimited liability. When big problems occur, limited partners are only liable to the extent of their capital contributions to the business (original investment plus accumulated profits).

Limited partnerships are often seen in real-estate and many other investment opportunities, where there is a desire to invest or loan funds for the purpose of realizing income or tax advantages. Limited partners usually have little interest in actually rolling up their sleeves to make the business work better; this is the job of the general partners, who desire to operate without the counsel of meddling outsiders. In fact, limited partners must be careful not to become involved in the business, or the law may consider that the hapless limited partner is actually a general partner and is therefore responsible for all obligations of the company.

The Partnership Agreement

Partnership agreements are not required. Oral agreements may actually be binding for general partners, but not with limited partners. However, for all practical purposes, it is necessary to construct an agreement describing the obligations, responsibilities, income, and ownership for each general partner (and perhaps limited partner). The partnership agreement often further describes business operations, goals, and background information for the limited partner investors. An attorney may draft these for $1,000 to $5,000, depending upon the “special twists” needed in comparison with standard boiler-plate partnership agreements. Although this start-up expense is pricier than what one would pay for sole proprietorships or most corporations, cost should certainly not be a significant factor in determining which business ownership form to use.

Unless the partnership agreement says otherwise, a partnership terminates upon the death, disability, or withdrawal of any partner. When this is not desirable, partners may agree (in the partnership agreement) to permit the remaining partners to purchase the interest of the deceased partner. Other associated problems can be solved through the use of specially constructed partnership agreements and careful tax planning.

To register a new small business partnership, most states require filing a certificate with the secretary of state. This also secures the name (although use of the name may well be contested without a trademark), indicates how meetings will be called and held, and describes legal and statutory requirements.

Tax Treatment

Partnerships must file income tax returns at the federal level and--if your state collects income taxes--at the state level as well. Form 1065 (U.S. Return of Partnership Income) is basically an income statement and is filed with the IRS. Actually, the partnership pays no taxes. Instead, the IRS is informed of the name and taxpayer identification number of each partner, and partners are given the same information on IRS Schedule K-1. Amounts from the K-1 are then transferred to Form 1040 (Individual Income Tax Return), the personal returns of partners.

General partners’ income and losses are considered to be “at-risk.” This means that their personal assets are available to creditors if problems occur. Therefore, the IRS allows these monies to be classified as active income or loss. This may be netted against other forms of active income such as normal employment wages and salaries from the partnership itself. This is useful in minimizing taxes.

Conversely, limited partners’ income and losses are not at-risk, so the IRS classifies this as passive income or loss. Passive amounts cannot be used to shelter (offset) active income but must be netted against other forms of passive income and loss (for example, investment gains and losses, interest income, and interest expense). Passive losses are often less useful in sidestepping federal and state income taxes.