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Types of Business Entities | Partnerships

Posted by Rick J. Alfera, CPA, MST, PFS on Apr 10, 2017 12:14:00 PM
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This is our third post in our series on Types of Business Entities. In our
first blog post of this series, we covered areas to consider when structuring a business. In this post we'll take a look at these areas again while discussing the advantages and disadvantages of partnerships.

According to the United States Small Business Administration;
"A partnership is a single business where two or more people share ownership. Each partner contributes to all aspects of the business, including money, property, labor or skill. In return, each partner shares in the profits and losses of the business."

There are three types of partnerships; General, Limited, and Joint Ventures. The definition above applies to General and Limited partnerships. The below definition applies to Joint Ventures.

According to the United States Small Business Administration;

"A joint venture is a mutual agreement between businesses to form a new business entity to undertake a business-related project together or to undertake some form of economic or business activity. Joint ventures may be negotiated between a corporation, limited liability company (LLC), partnership or other legal business structures."

General and Limited Partnerships include two or more partners within a company. Whereas joint Ventures exist as short-lived contractual arrangements between two or more companies. Joint ventures are usually created for a specific task or project. They exist as their own separate entity from the participants' other business interests.

Areas to Consider:

  • Effort 
  • Tax
  • Documentation
  • Control
  • Funding
  • Liability

Effort:

Legal partnership agreements are the most important aspect of forming a partnership. Developing the legal partnership agreement takes the most time and can cost significant money. Limited partnerships are also subjected to filing fees.  See bottom of post for resources on developing legal partnership agreements.

  • Establishing a Business Name - Easy. Its legal name is the name given in the partner agreement or the last names of the partners. It can also operate under a name other than the registered name via a filed fictitious name.
  • Business registration - Easy. Upon establishing a name, partnerships must obtain all necessary licenses and permits.
  • Ongoing Administration - Minimal. There aren't reporting requirements, like that of a corporation, to weigh down on an owner's management efforts.

Tax:

In regards to tax, the following areas are some of those affected by business type:

  • Federal, State, & Local Taxes - These business structures are subject to federal, state, and local taxes on their net profits. Some other company structures are only taxed on W2 wages.
  • Income tax - None. Profits or losses are recorded on each of the partners' individual tax returns.
  • Employees - These businesses only pay unemployment tax on employees. Partners are not considered employees.

Documentation:

Partners must receive schedule K-1s (Form 1065). K-1s report any information such as income, gains, losses, deductions, and credits within the partners' individual returns

Click here for more tax and documentation information on partnerships.

Control:

Partners have split control and responsibility for the company. In other words, they must negotiate and agree upon important business management decisions. This can slow down the decisions making process. Establishing a formal decision or evaluation processes may be necessary. This can prove frustrating for some individuals.
 
For many, the added strengths, resources and expertise of each of their partners may outweigh any sacrificed control.
 

Funding:

Partners split the investment in their business. Meaning capital is easier to build compared to Sole Proprietorships, as there are more contributors. More contributors means there's more opportunity for securing credit, as well as increased venture capital. Partnerships may be advisable for individuals who can't fund their business on their own.

Liability:

Partners are accountable for all their business's debts, losses, and liabilities. In other words, acting as a partner may not be in the best interest of an individual whose business and/or business partners expose them to risk of debt or lawsuit. Being accountable for all their business's liabilities means all partners' assets are at risk. This includes any business debts or decisions made by other partners. However, certain types of partnership arrangements, such as Limited Liability Companies or Limited Partnerships, can offer liability protection.

Overview:

  • Partnerships are best for two or more individuals who wish to share responsibility and run a collaborative business.
  • Owners may appreciate the simplicity of forming a partnership.
  • Partners may want to consider other entity types for tax advantages.
  • Individuals who prefer complete control over the decision making processes may not be suited for a partnership.
  • The ability to double venture capital and increase credit opportunities may attract individuals to this entity type.
  • Owners should keep in mind that their personal assets are vulnerable to the risks involved in their company. Furthermore, not only are they responsible for their own actions but also for any business debts or decisions their partners make.

Extra Resources:

 

Stay tuned for our next blog post of this series where we will be discussing the advantages and disadvantages of Corporations.

Topics: Different Types if Business Entities, Structuring Your Business, Partnerships

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