What Is a Partnership?
Section 6 of the Uniform Partnership Act defines a partnership as an association of two or more persons to carry on as co-owners a business for profit.
There are no IRS licensing requirements for partnerships. However, for state and local purposes you may need a business license and/or sales tax permit if you sell merchandise at retail. Check with your state.
Tax Identification Number for a Partnership
Although the partnership entity is not a tax-paying entity, it is a tax-reporting entity and is required to have its own federal employer identification number (EIN).
Reporting Income and Losses of a Partnership
A partnership files Form 1065 annually with the IRS to report income, deductions, credits, gains, and losses.
A Partnership is a Pass-through Entity
The partnership entity does not pay taxes. Income, deductions, credits, gains, and losses are passed-through the entity to each partner according to each partner's proportionate interest in the partnership.
Each partner receives Schedule K-1 annually from the partnership reporting his share of income, deductions, credits, gains, and losses which are reported on each partner's personal income tax return.
Forming a Partnership
Forming a partnership is a voluntary act not one imposed by law. A partnership is easy to form. As long as two or more people agree to operate a business for profit, a partnership exists.
As a general rule, a partnership agreement doesn't have to be in writing, however, a written agreement is highly recommended. Having to rely on, "I thought we agreed..." when a problem arises is just not very wise.
Having a written document to refer to for resolving future situations that were anticipated and written down when the partnership was started makes sense.
For example, what if a partner dies or wants to sell his interest? How will these events be handled?
If the partnership anticipated such events from the start and agreed in writing to the procedure for dealing with them, a smooth resolution could be achieved and hard feelings spared.
Types of Partnerships
A general partnership is created for the general conduct of a particular kind of business. It is governed by the Uniform Partnership Act. Each partner is personally liable for partnership debts and each partner is jointly and severally (separately) liable for all torts committed by employees or any partner in the scope of partnership business.
Tort: A private or civil wrong resulting from the breach of a legal duty owed to someone.
A limited partnership is created by statute (the Uniform Limited Partnership Act). Limited partners only invest capital in the partnership and expect a return on their investment.
A limited partner's liability for partnership debts is limited to his investment. Limited partners are not allowed to actively participate in the management of the partnership. If they do, they risk losing their limited liability protection.
All states have adopted the Uniform Partnership Act and Uniform Limited Partnership Act. As a result, state laws governing partnerships are similar. There is no federal partnership law.
Each partner owns a fractional interest in the partnership. Partners will generally agree on the percentage of their individual interest based on the amount of capital they contribute and/or the level of expertise provided to the business.
If a partner is sued, the Charging Order mechanism prevents a judgment creditor from proceeding against the assets of the partnership. This legal limitation allows the remaining non-debtor partner(s) to continue to operate the business unimpeded. The Charging Order only permits a judgment creditor to proceed against the debtor-partner's interest in the partnership.
This Charging Order allows for the following procedure:
- Payment of the debtor-partner's share of any profits to be paid to a receiver on behalf of the creditor, or
- The court may direct the sale of the debtor-partner's interest in the partnership.
Articles of Partnership
Articles of Partnership (also called, partnership agreement) set forth each partners rights and obligations to the partnership. It is highly desirable to have a written agreement that sets down the procedures for handling anticipated points of dispute, should any arise, and provides for a more harmonious working relationship among the partners.
Workers' Compensation Insurance
State law requires all businesses with employees to carry workers' compensation insurance. However, since partners are not employees of the business, they are not covered under workers' compensation insurance.
workers' compensation insurance covers employees injured on the job, even if the employee caused the injury. It's like no-fault Insurance. The premiums for this insurance vary depending on the level of risk for injury associated with the employee's job.
For example, an employee who is required to handle combustible chemicals has a higher degree of risk of injury than a bookkeeper working in the office.
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- Return to the Tax Basics for Startups Table of Contents to find related links.