Business structures help protect owners from liability and enable them to maximize the tax benefits of running a business.
A partnership business structure is one of the simplest ways for two or more people to run a business together.
The Most Common Business Partnership Structures
One of the first decisions business co-owners must make is what type of structure works best for their business. There are two common types of formal partnerships: limited partnership (LP) or limited liability partnership (LLP).
Limited Partnership (LP)
A limited partnership features a general partner who has unlimited liability, while all other partners have limited liability. The general partner is the operation’s hands-on person. Limited partners may be silent partners who help fund the startup of the business and are not involved with day-to-day operations.
Profits are reflected on the personal tax returns of all the partners. The general partner takes on the responsibility of paying self-employment taxes on partnership profits. Partners with limited liability also have limited control over how the company operates.
Limited Liability Partnership (LLP)
A limited liability partnership works in much the same way as a limited partnership. The key difference is that under an LLP, every partner has limited liability. An LLP separates every owner’s personal finances from those of the business. Personal assets—bank accounts, property, vehicles, etc.—are protected if legal actions are brought against the company. These assets are also protected against the company’s creditors or the debts of other partners. Most LLPs hire a business manager to oversee daily operations.
General Partnerships and Limited Liability Limited Partnerships
A general partnership does not require filing paperwork with the state. Typically, two or more people form a partnership by agreeing to a written partnership. The partners file taxes under their own names. A general partnership offers no liability protection, which is one of the main advantages people seek when forming a business structure.
The Limited Liability Limited Partnership (LLLP) structure is a recent addition to partnership types. An LLLP operates like an LP, with a general partner managing the day-to-day business. However, it also limits the general partner’s liability so that every partner has protection.
Who Should Form a Partnership?
A partnership works well for companies with more than one owner, professional groups that want the benefits of a partnership but don’t want to run the business (such as attorneys or doctors), or owners who want to try out a new business before creating a more formal business structure like an LLC or corporation.
Entrepreneurs may decide on a partnership business structure if their business falls into one of the following categories:
- The business has multiple owners.
- It is a low-profit, low-risk business.
- It has a limited customer base.
- It is an enterprise transitioning from a hobby into a business.
How Do You Form a Partnership?
A general partnership requires only a partnership agreement between two or more people. In theory, you could start a business on a handshake, but experts recommend a written agreement.
The other partnership structures (LP, LLP, LLLP) require registering with the state where the business is located. Forming these types of partnerships also require owners to establish certain aspects of a formal business, such as creating business banking accounts and obtaining required permits and licenses. Some states may allow a business to register online; others may require documents be submitted in person or through the mail. According to the U.S. Small Business Administration, most states also require registration with the secretary of state’s office, a business bureau, or a business agency.
Challenges of Forming a Partnership
Liability: General partners have unlimited liability, meaning they must carefully choose with whom they enter into a partnership since they are responsible for the partnership’s liabilities. In some cases, a creditor can pursue a single general partner for the obligations of the business.
Self-employment taxes: A general partner must pay self-employment taxes on income received through a partnership. A limited partner does not pay self-employment taxes on their share of a partnership’s income, but does pay self-employment taxes on any guaranteed payments, according to the IRS. Guaranteed payments involve payments for any services rendered to or on behalf of the partnership.
Advantages of a Partnership
- Liability protection: This extends only to limited partners, not general partners in an LP structure.
- Capital investment: Pooling the resources of the partners allows for creation of a better business than trying to run it alone.
- Specialization: Either through a general partner or a business manager, partners can bring in professionals with expertise in business operations rather than try to run a business on their own.
- Simple tax filings: Partnerships file Form 1065 and report income on their personal taxes, usually with a Schedule K-1.
- Avoid double taxation: Profits pass through to the partners, rather than first getting taxed at the corporate rate as with a C corp.
Evaluating the requirements, advantages, and challenges of a setting up a partnership is essential before deciding if it’s the right legal entity for your business.