What is a Partnership?
A partnership is a form of business where two or more people share ownership, as well as the responsibility for managing the company and the income or losses the business generates. That income is paid to partners, who then claim it on their personal tax returns – the business is not taxed separately, as corporations are, on its profits or losses.
There are three types of partnerships:
- General partnership
- Limited partnership
- Joint venture
In a general partnership, each partner shares equally in the workload, liability, and profits generated and paid out to the partners. All partners are actively involved in the business’s operations.
Limited partnerships allow outside investors to buy into a business but maintain limited liability and involvement, based on their contributions. This is a more complicated form of partnership, which also has more flexibility in terms of ownership and decision-making.
Short-term projects or alliances that bring together multiple partners for a project are typically structured as joint ventures. If the venture performs well, it can be continued as a general partnership. Otherwise, it can be shuttered.
There are several advantages of choosing to structure a business as a partnership, which include:
- Fairly easy to set up and maintain over time
- Partners can pool their resources to fund the company’s start-up
- Partners can share the workload and the rewards of the business’s success
- Being able to offer key employees the potential to one day become a partner in the business can be a big carrot that encourages them to stay long-term
Of course, where there are advantages, there are also disadvantages to forming a partnership:
- Where more than one owner exists, there are bound to be differences of opinion that could threaten the business
- Although partners split any profits the business generates, if the payout is not in sync with each partner’s contribution to the company, disagreements can erupt
- Unlike corporations, which help to shield owners from liability, partnerships have both joint and individual liability. That is, all partners are liable for their own actions on behalf of the company as well as the actions of the other partners.
There are no annual taxes to be paid, but the partnership does need to issue a K-1 form to all partners to be included in their personal income tax filings.
The takeaway here? Be careful who you go into business with, because you could be liable for their actions as they relate to the business.