What Does It Take to Form a Business Partnership?

Business Partnership

Entrepreneurs who want to start a company with one or more other people may be unaware that there are many types of business partnership. In this post, We will go through the various type of partnerships and what it takes to establish and sustain them.

When choosing a business entity form, business owners should bear in mind that there are legal and tax implications to consider. So, before making a decision, seek advice from an attorney, accountant, or tax advisor.

Related: How to Find Business Opportunities Near Me

What is a Business partnership?

When two or more parties agree to go into business together and share gains and losses, they form a partnership. Depending on the form of relationship, partners’ responsibilities in operating the company and their personal responsibility for business debts differ. Partnership income tax obligations are passed on to the company owners’ individual tax returns. While partnerships do not pay income tax at the corporate level, they must comply with reporting requirements. As a result, they need an EIN from the IRS in order to file taxes.

Following that, I’ll go over the three most common forms of partnerships:

Limited liability partnership
General partnership
Limited partnership

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Limited Partnership (LP)

Limited partnerships are publicly licensed corporate entities with the state. The opportunity to bring on investors to invest in the business without paying the cost and paperwork of creating a limited liability company (LLC) or corporation is one reason entrepreneurs may prefer this type of partnership. A partnership agreement is used to record each partner’s percentage of income and to identify each partner’s obligations.

A limited partnership (LP) consists of at least one general partner and one or more limited partners. Limited partners contribute funds but do not actively participate in the day-to-day operations of the company.

As a result, they are protected from responsibility for the partnership’s debts and legal disputes (to the extent of their investment in the business). The general partner(s) of an LP is in charge of the company’s activities and management.

Those people are personally liable for the business problems indefinitely. As a result, creditors or lawsuits will go after the personal properties of general partners but not limited partners.

In a limited partnership, general partners are not paid the salaries of the corporation. Income tax and self-employment taxes apply to their income from partner draws or fixed payments to reimburse them for their work in the sector.

Limited partners benefit from the company depending on their share of the profits in a limited partnership. Throughout the year, the company may make periodic payments or partner draws to limited partners.

Limited partners’ earnings from the company are subject to payroll tax but not self-employment taxes because they earn passive income from their monetary investment rather than income for the work performed in the business.

If a limited partner is paying fixed compensation for any job they are permitted to do for the company, the income is subject to Medicare and Social Security taxes in addition to income tax.

How to Start an LP

Filing a Certificate of Limited Partnership with the state and paying the required registration fees is the first step in forming a limited partnership. For tax reporting purposes, an LP must receive an EIN from the IRS.

The LP can continue to exist even if limited partners quit or are replaced. Unless the business partnership agreement says otherwise, some states compel the other partners to dissolve the LP if a general partner leaves.

Compliance Tasks for LPs
Annually send a report to the state.
In the state, appoint and retain a registered agent.
Income and self-employment taxes must be reported and paid.
Apply for a sales tax identification number (seller’s permit).
Payroll taxes must be registered (if the business will have employees).
Franchise tax must be charged.
Obtain and maintain the required business licenses and permits.
Separate the personal finances of a company and its partners.

Limited Liability Partnership (LLP)

A limited liability partnership is similar to a general partnership in that both members may participate in company management. In contrast to a general partnership, however, both of the partners are shielded from personal responsibility. Entrepreneurs in specialized professions are more likely to use this type of business structure.

In addition to providing personal liability insurance, the LLP arrangement allows professionals to pool resources (such as administrative personnel, vehicles, and so on) and lower operational costs when opposed to working independently. In most jurisdictions, all LLP partners must be accredited in the same profession.

Even though they have full responsibility for the management of the company, all partners in an LLP are individually shielded from the business’s liabilities (the extent of liability security varies by state). An LLP’s partners are compensated out of the company’s earnings, which are subject to income and self-employment taxes.

Starting an LLP

A “Certificate of Limited Liability Partnership” is the name given to the paperwork required to form an LLP. It must be filed with the relevant state agency and the proper fee must be paid.

It’s worth noting that the LLP isn’t recognized in every state, and some states only allow some types of professionals to join one.

Individual partners may leave or pass away, but LLPs may continue to exist if the relationship agreement specifies this.

Compliance Tasks for LLPs
Annually send a report to the state.
In the state, appoint and retain a registered agent.
Income and self-employment taxes must be reported and paid.
Apply for a sales tax identification number (seller’s permit).
Payroll taxes must be registered (if the business will have employees).
Franchise tax must be charged.
Obtain and maintain the required business licenses and permits.
Separate the personal finances of the company and its shareholders.

General partnership

It is the most basic type of relationship, and it normally does not necessitate state agency registration paperwork. Unless the partnership’s terms say otherwise, ownership and profits are divided evenly among the partners in a general partnership. Since there is no formal distinction between the corporation and its owners, both shareholders share responsibility for the company’s debts and legal obligations.

General partnerships are easy to create and sustain, making them a good choice for entrepreneurs who want to keep their administrative and regulatory burdens to a minimum.

They are not limited in the number of partners they can have. A general partnership’s members are not considered employees of the firm. As a result, they do not earn a paycheck from the company by payroll. Taking an “owner’s draw” or “partner draw” allows partners to get paid by removing funds from their share of the profits. For their share of company earnings, general partners pay both income tax and self-employment taxes (Medicare and Social Security).

How to begin a GP

Even when there is no written arrangement or partnership agreement in effect, a partnership is formed when its owners decide to do business together. A partnership agreement that maps out the positions, obligations, and benefit allocation of the company owners is useful to ensure that all partners are on the same page.

If the partnership agreement allows it, a GP can continue to exist after one or more partners have left the company. Otherwise, the company would have to be shut down.

GPs’ Potentially Ongoing Compliance Tasks
Income and self-employment taxes must be reported and paid.
Apply for a sales tax identification number (seller’s permit).
Payroll taxes must be registered (if the business will have employees).
Obtain and maintain the required business licenses and permits.

Is Partnership the right way for your business?

One of the most important choices you’ll have to make is what business structure to use. Consider seeking advice from trusted legal and accounting experts because your decision will impact so many facets of your business—how you run it, how taxes are done, your level of personal responsibility, and more. Since every situation is different in some way, it’s a good idea to think about the advantages and disadvantages of your particular situation before moving forward.