There are several different types of partnerships, and the one you choose to form will have distinct implications on how your business operates.
There are three main types of partnerships to choose from: general, limited, and limited liability. Read the following important information to help you and your partner(s) choose the right structure for your business:
- What is a partnership?
- Main types of partnerships in business
- Tax protocol for different types of partnerships
- Different types of partnerships: pros & cons
- How to document the type of partnership you’ve selected
1. What is a partnership?
A partnership is a business owned by two or more individuals (partners) who share the business’s profits and losses based on their agreed-upon share of ownership.
Partnerships are popular business structures because they’re quick and easy to form with little or no formal documentation required by law.
If you do choose to operate your business as a partnership, use a partnership agreement to detail the terms of the relationship, such as your:
- Partner’s information
- Profit and loss distributions
- Initial contributions
- Management structure
- Description of operations
- Type of partnership
Types of Partners
In a partnership, you can either be a general partner or limited partner. Make sure you understand the rights and responsibilities (as well as the limitations) of being either type before you begin filing any documents.
A general partner manages the business and takes responsibility for its day-to-day operations. They’re fully liable for the partnership’s debts, and their personal assets can be seized to settle debt obligations or lawsuits.
Limited partners hold financial stakes in the business, but they don’t play a role in management. Therefore, limited partners are not personally liable for its debt, and the most they can lose is whatever they’ve invested.
2. Main types of partnerships in business
There are three common types of partnership arrangements: general partnerships, limited partnerships, limited liability partnerships.
1. General Partnership (GP)
How they’re structured
In a general partnership, all partners share equal rights and responsibilities, and each partner can sign contracts on behalf of the business. The partners or non-partner managers (similar to a corporate board of directors) must obtain unanimous or majority agreement before making major decisions.
Along with sharing profits and losses, partners assume unlimited liability for the debts and obligations of the partnership — known as joint and several liability. This means that if the partnership is sued because of the negligence of a partner, the other partners are also held liable, and their personal assets may be seized by a creditor.
Why choose a general partnership
Partners are not required to create or file any formation documentation to formally establish a general partnership and begin operating, making them a convenient option.
2. Limited Partnership (LP)
How they’re structured
A limited partnership is made up of general and limited partners. Both types of partners are entitled to business profits, but have different roles and degrees of liability.
A limited partnership needs at least one general partner to function, because they’re responsible for running the business. Limited partners, often referred to as silent partners, contribute capital to the partnership but don’t manage daily operations.
General partners must also accept full joint and several liability for the partnership’s debts and obligations. Limited partners are not liable for the actions of the partnership or its general partner.
Why choose a limited partnership
A limited liability partnership is an attractive option if you have investors who want to financially contribute to the company, but don’t want to deal with management responsibilities or liability.
3. Limited Liability Partnership (LLP)
How they’re structured
Limited liability partnerships combine the tax benefits of a general partnership with personal liability protection of a limited liability company.
Each partner is able to choose how much they’d like to invest in the partnership, as well as their level of involvement in the business.
All LLP partners are essentially general partners, but with limited liability — in other words, they’re not personally liable for business debts and obligations or the errors, omissions, negligence, incompetence, or malpractice of the other partners. For example, if one partner is sued for negligence, the other partners are not legally accountable for their actions.
Why choose a limited liability partnership
Limited liability partnerships are often created by professionals to optimize resources and save money. For example, two dentists might form a limited liability partnership to share the costs of renting and renovating office space, buying expensive dental equipment, and hiring staff.
In some states, LLPs are limited to professional partnerships, such as doctors, lawyers, architects, accountants, and the aforementioned dentists. Unlike other types of partnerships, LLPs need to be registered with the state and require a written agreement.
3. Tax protocol for different types of partnerships
The tax protocol for general partnerships, limited partnerships, and limited liability partnerships are the same: the partnership files Form 1065 with the IRS, and each owner files a Schedule K in their personal tax return, showing their share of the partnership profits or losses for the year. Each partner pays income tax on their share of the net income.
While LLPs are taxed as partnerships at the federal level, be aware that some states may impose non-partnership taxes on limited liability partnerships. For example, Texas LLPs have to pay a franchise tax along with corporations and LLCs.
4. Different types of partnerships: pros & cons
Here’s a chart detailing the pros and cons of each type of partnership business to help you decide which one is right for you:
|General Partnership||- Fewer start-up costs|
- Little to no paperwork
- Simplified taxes
|- Joint and several liability
- Shared management
- Unattractive to investors
|Limited Partnership||- Limited liability for limited partner|
- Attractive to investors
- Tax benefits
|- Joint and several liability for general partners
- More paperwork
- Divided authority
|Limited Liability Partnership||- Limited liability for all partners|
- Flexibility for partners
- No double taxation
|- Formal filing requirements
- Formation limited by certain states
- Additional taxes in some states
5. How to document the type of partnership you’ve selected
The type of partnership you select will impact the management, taxation, legal status, investment, and start-up requirements of your company.
Once you and your business partners have decided whether to operate as a general, limited, or limited liability partnership, make sure to document the terms of the arrangement in a partnership agreement.