Partnership

Definition

A partnership is a formal arrangement by two or more parties to manage and operate a business and share its profits. A partnership originally arises from a formalized agreement, but in practice, a partnership can form even when there is no written agreement. Within the scope of a partnership, either partner can bind the other(s) to contracts and obligations related to the business purpose. Each partner in a partnership is logically responsible for the debts and obligations of the partnership, and they typically pay no partnership-level taxes. Instead, profits or losses pass through to individual partners, who then report these on their personal income tax returns.

Key Characteristics

Joint Business Operations: Partners collaboratively run the business and share its profits and losses.
Binding Authority: Each partner can commit the partnership to binding agreements.
Personal Liability: Each partner is personally liable for the partnership’s debts and obligations.
Flow-through Taxation: The partnership itself pays no taxes; instead, earnings are distributed to partners, who then pay personal tax on their share.

Examples

Example 1: Abel and Baker decide to purchase a strip of land for the purposes of developing it and potentially reselling at a profit. They form a partnership named “AB Land Investors.” The partnership, not Abel and Baker individually, owns the property.
Example 2: Two architects, Steph and Greg, agree to start an architectural firm by pooling their resources and talents. They form “SG Architects,” a partnership through which they offer their services, share responsibilities for rented office space, business resources, profits, and losses.

Frequently Asked Questions

What are the types of partnerships?

General Partnership (GP): All partners share both the management of the business and the liability for its debts.
Limited Partnership (LP): Comprises both General Partners, who manage and are liable, and Limited Partners, who are passive investors with limited liability.
Limited Liability Partnership (LLP): Similar to a GP but offers liability protection to all partners.
Limited Liability Company (LLC): While technically not a partnership, it can be structured to function like one with the benefit of limited liability for all its members.

What happens if one partner wants to leave the partnership?

The partnership agreement often outlines the process of a partner exiting the partnership, covering aspects such as valuation, compensation, and operational transition. In the absence of such an agreement, state laws typically prescribe the process which might lead to dissolution and reformation.

How is a partnership dissolved?

Partnership dissolution can occur voluntarily if all partners agree or due to a partner’s withdrawal or death, by legal mandate if certain conditions are met, or by court order if the business is found to be impracticable. Once dissolved, partners must settle debts and distribute any remaining assets.

What are the advantages of forming a partnership?

Key advantages include simplicity and flexibility in management, pass-through taxation benefits, and the pooling of resources and expertise. Partnerships often involve less regulatory burden than corporations.

What are the disadvantages of forming a partnership?

The primary disadvantage is unlimited personal liability for debts and obligations unless structured as a LP, LLP, or LLC. Disagreements or natural dissolution due to partner exit or death can also complicate business operations.

General Partner: A member of a partnership possessing authority, responsibilities, and liability for the partnership’s actions, akin to an owner with joint administrative powers.

Limited Partnership (LP): A hybrid partnership with two or more partners, including at least one General Partner (fully liable) and one Limited Partner (liability restricted to their investment amount).

Limited Liability Partnership (LLP): A partnership in which individual partners have limited liabilities, shielding them from debts against the partnership incurred by other partners.

Corporation: A legal entity separate from its owners, providing liability protection to its shareholders but subjecting income to corporate tax before dividends are taxed on personal income returns.

LLC (Limited Liability Company): A flexible business structure that provides liability protection to its members while allowing pass-through taxation, similar to a partnership.

Online Resources

References

US Internal Revenue Service, “Partnerships.” IRS.gov.
Small Business Administration (SBA), “Choosing a Business Structure.”
Uniform Partnership Act (UPA).

Suggested Books for Further Studies

“Partnership Taxation” by Michael Lynch
“The Partnership Charter: How To Start, Run & Grow Your Business” by Bob Adams
“Drafting a Partnership Agreement: 30 Tips and Tools for Business Success” by Stephan Fischman

Real Estate Basics: Partnership Fundamentals Quiz

### What type of taxation applies to partnerships? - [ ] Corporate-level taxation - [ ] Double taxation - [x] Pass-through taxation - [ ] VAT > **Explanation:** Partnerships use a pass-through taxation system, meaning profits or losses pass through to individual partners who then report this on their personal income tax returns. ### In which type of partnership is at least one partner fully liable for the partnership's debts, while others have limited liability? - [ ] General Partnership - [x] Limited Partnership - [ ] Corporation - [ ] Limited Liability Partnership > **Explanation:** In a Limited Partnership (LP), there must be at least one General Partner with full liability and one or more Limited Partners with liability limited to their investment. ### Which of the following best describes a General Partner's role and responsibility? - [ ] Passive investor - [x] Active in management and fully liable for partnership debts - [ ] Has limited liability only - [ ] Works hourly for the partnership > **Explanation:** General Partners actively manage the partnership and hold full liability for its debts and obligations. ### What is one of the major disadvantages of a General Partnership? - [x] Unlimited personal liability for business debts - [ ] Double taxation - [ ] Difficulty in obtaining financing - [ ] Shares freely traded on stock markets > **Explanation:** One of the persistent disadvantages of General Partnerships is that the partners have unlimited personal liability, meaning their personal assets could be at risk to cover business debts. ### What advantage does a partnership have over a corporation in terms of tax treatment? - [ ] Lower corporate tax rates - [ ] Access to public markets easily - [x] Pass-through taxation - [ ] No tax obligations whatsoever > **Explanation:** The advantage of a partnership over a corporation is the pass-through taxation, preventing double taxation where business income would otherwise be taxed at both corporate and individual levels. ### Which type of partner is not involved in the day-to-day management but invests capital into the partnership? - [x] Limited Partner - [ ] General Partner - [ ] Managing Partner - [ ] Silent Partner > **Explanation:** Limited Partners invest capital into the partnership but do not involve themselves in the day-to-day management, having liability limited to their invested amounts. ### If a partner leaves or passes away, what generally happens to the partnership? - [ ] It gains new stock options - [ ] It becomes a corporation - [ ] It continues without any changes - [x] It can dissolve unless an agreement states otherwise > **Explanation:** A partnership typically dissolves if a partner leaves or passes away unless a specific agreement provides for continuity. ### Why might partners choose to form a Limited Liability Partnership (LLP)? - [ ] To avoid all taxes - [ ] To operate publicly - [x] To protect partners from debts and liabilities incurred by the partnership > **Explanation:** A LLP provides liability protection to its members, meaning partners are not personally responsible for the debts and liabilities incurred by the partnership due to actions by other partners. ### What is a key element that must exist for an entity to be considered a partnership? - [ ] Incorporation papers - [x] An agreement between parties to share profits and losses - [ ] Double taxation structure - [ ] Public listing on a stock exchange > **Explanation:** A business arrangement is considered a partnership if there is an agreement between parties to share profits and losses. ### How do general partners differ from limited partners in a Limited Partnership (LP)? - [x] General partners manage the business and are fully liable, while limited partners do not manage and have limited liability - [ ] Limited partners mange the business and are fully liable, while general partners do not manage and have limited liability - [ ] Both have full management responsibilities - [ ] Neither are involved in management or have any liabilities > **Explanation:** General partners actively manage the business with full liability, while limited partners do not manage and their liability is limited to their investment.