In our last post, “Organizing Your Business Part 1: Sole Proprietorships,” we talked about a type of DBA that has just one owner. Today we’re going to delve into partnerships, types of businesses owned by two or more parties. There are two types of partnership: general and limited.
A general partnership occurs when two or more persons own, manage, and control a business. Persons in a general partnership share the rights, duties, and responsibilities. Partnerships may also have employees; however, only the partners have control of the business activities.
A partnership has more issues to address than the sole proprietorship. Besides obtaining the appropriate licenses and registering the business name, partners must agree on the treatment of business profits, expenses, losses, and other business concerns. Typically, there is a written agreement between the partners to address these issues. Individual states have statutes that specifically govern partnerships.
General Partnership: Pros
The benefits of a general partnership include the owners’ control of a business. However, unlike the sole proprietor who has exclusive control, partners share control and responsibilities. Partners have the advantage of having more than one resource for finances, ideas, and sharing the work load. The formation of a general partnership can be less complicated than other business formats, such as limited partnerships and corporations. Finally, profits from the partnership are included on the partners’ individual tax returns and taxed at the individual taxpayer rate, which is lower than the rate charged to corporations.
General Partnership: Cons
The drawbacks to a general partnership include being personally responsible for the debts and liabilities of the partnership just like a sole proprietorship. A partner can be liable for debts incurred by other partners in furtherance of the business. A partnership may obtain insurance to minimize this drawback. Business partners are treated like sole proprietors with regard to deducting benefits provided to themselves. Benefits like health, dental, and life insurance may generally not be deducted on partners’ income tax returns as business expenses.
In a general partnership, a business can continue after the departure or death of a partner. State laws govern how to deal with the death of one of the partners. In general, a partnership agreement may detail how a partnership interest may be sold, transferred, or handled upon the death of a partner. Addressing potential issues in an agreement may be one way to prevent disputes from occurring.
A limited partnership is similar in many respects to a general partnership. However, in a limited partnership, there are two types of partners—general and limited. Some states require that a limited partnership have at least one general partner and one limited partner. The principal difference between a general and limited partner is that the limited partner can limit his personal liability for partnership debts to the amount he invests in the partnership. The limited partner, in exchange for the reduction in liability, does not control or manage the business. The general partner controls and manages the business and is personally liable for partnership debts.
Because limited partnerships must meet specific statutory requirements, they can be more complicated to establish and often require regular public filings. A limited partnership must also receive appropriate licenses, tax identification number and register the business name.
Limited Partnership: Pros
The benefits of a limited partnership depend on whether one is a general or limited partner. The general partner enjoys control and management responsibilities. The limited partner receives limited personal liability. Profits for both types of partners are included on the partners’ individual tax returns and taxed at the individual taxpayer rate, which is lower than the rate charged to corporations.
Limited Partnership: Cons
The drawbacks for a limited partnership also depend on whether one is a general or limited partner. A general partner is personally responsible for the business debts while the limited partner is only liable for debts up to the amount invested in the partnership. The limited partner does not participate in the management or the control of the business. Business partners are treated like sole proprietors with regard to deducting benefits provided to themselves. Benefits like health, dental, and life insurance may generally not be deducted on partners’ income tax returns as business expenses.
[This has been Part 2 of our 4-part Organizing Your Business series. For our next installment, please see “Organizing Your Business Part 3: Corporations.”]