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What Is a Partnership?
Partnership Defined
A partnership comes into existence when there is an agreement between at least two persons to carry on a lawful business and share its. While most states have adopted the Revised Uniform Partnership Act (RUPA), some have retained the Uniform Partnership Act (UPA) and some states have modified certain provisions of their versions of the uniform acts. This can be a confusing area of law. Be sure to check your state's partnership rules.
The Partnership Agreement
Unless a partnership agreement exists, the state's default rules may apply to situations that arise in a partnership. For example, without a partnership agreement in place, the state's default rules generally assume that partners have invested an equal amount of time and resources into the business, which is generally not actually the case. However, under state's default rules, profits and losses will be split equally in the event of partnership dissolution. Be sure to seek legal advice on preparing a partnership agreement to avoid any surpirses.
A partnership agreements provides you and your partner(s) a means to formally deal with management issues, contributions of capital, allocation of profits and losses, distributions, death of a partner, etc.
Licensing Requirements
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.
Tax Identification Number for a Partnership
A partnership is not a tax-paying entity, it's a tax-reporting entity and is required to have its own federal employer identification number (EIN). A partnership files Form 1065 annually with the IRS to report income, deductions, credits, gains, and losses. It issues Schedule K-1 to each partner to report each partner's share of these items. Partners report K-1 items on their individual income tax return.
A Partnership is a Pass-through Entity
Taxes are not paid at the entity level. Partnership 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 is subject to taxes on partnership income and may deduct parnership losses on his/her individual income tax return.
Types of Partnerships
General Partnership:
A general partnership is created for the general conduct of a particular kind of business. General partners run the eveyday operations of the business. In a general partnership each partner is personally liable for partnership debts as well as being jointly and severally (separately) liable for torts committed by employees or any partner in the scope of partnership business. A tort is a private or civil wrong resulting from the breach of a legal duty owed to someone.
Limited Partnership:
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.
Partnership Interest
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.
Charging Order
If a partner is sued, the Charging Order mechanism prevents a judgment creditor from proceeding against the assets of the partnership entity. 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.
The 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.
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 (similar to no-fault insurance). The premiums for workers' compensastion insurance vary depending on the level of risk of injury associated with the employee' 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.