What Is a Partnership? How Does It Work?

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What is a Business Partnership? 

A Partnership is a legal relationship formed by the agreement between two or more individuals to carry on a business as co-owners. A partnership is a business with multiple owners, each of whom has invested in the business. Some partnerships include individuals who work in the business, while other may include partners who have limited participation and also limited liability.

A partnership, as distinguished from a corporation, is not a separate entity from the individual owners. The partnership income tax is paid by the partnership, but the profits and losses are divided among the partners, based on their agreement.

How Does a Partnership Pay Income Taxes?

The partners are taxed from the income (or loss) of the partnership on their personal income tax return, and the partnership files an information return (Form 1065) with the IRS.

Multiple-member limited liability companies (LLCs) file income taxes as a partnership.

Check with your state's secretary of state to determine the requirements for registering your partnership in your state.

Types of Partners in a Partnership

Depending on the type of partnership and the levels of partnership hierarchy, a partnership can have several different types of partners. This article on different types of partners explains the difference between: 

  • General partners and limited partners. General partners participate in managing the partnership and have liability for partnership debts. Limited partners invest but do not participate in management. 
  • Equity partners and salaried partners.  Some partners may be paid as employees, while others have only a share in ownership. 
  • The different levels of partners in the partnership. For example, there may be junior and senior partners. 

Types of Partnerships

 Before you start a partnership, you will need to decide what type of partnership you want. You may have heard the terms:

  • A general partnership is composed of partners who participate in the day-to-day operations of the partnership are who have liability as owners for debts and lawsuits. There may also be limited partners
  • A limited partnership has one general partner who manages the business and one or more limited partners who don't participate in the operations of the partnership and who don't have liability.
  • A limited liability partnership is similar to the limited partnership, but it may have several general partners. 

Forming a Partnership

Partnerships are usually registered with the state in which they do business, but the requirement to register varies from state to state. Partnerships use a partnership agreement to clarify the relationship between the partners, roles and responsibilities of the partners, and their respective shares in the profits or losses of the partnership.

It is relatively easy to form a partnership, but, as noted above, the business must be registered with the state where the partners do business. Depending on the state, you may have the choice of one or more of the types of partnerships mentioned above. Once you have registered with your state, you can then proceed to the other typical tasks in starting a business. 

The Importance of a Partnership Agreement

When a partnership is formed, one of the first acts of the partners should be to prepare and sign a partnership agreement. This agreement describes all the responsibilities of the partners, sets out each partner's distributive share in profits and losses, and answers all the "what if" questions about what happens in a number of typical situations. 


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