Creating a business entity is an important part of protecting oneself from liability, establishing a more professional appearance, and more. However, knowing which type of business entity – as well as the details of each – to choose can be challenging as there are a number of different business entity types.
We provided an outline of various entity types you might use for your business in a prior post. In this post, however, we want to focus on partnerships.
It’s the Default
When two or more people decide to carry on a business for profit and they don’t take any action to form a specific business entity, most states will classify that business as a partnership. A partnership is much like other business entities in that it can sue and be sued, own property, and carry on a business, but that doesn’t mean it is the best option for your business.
You don’t even necessarily have to file documents with your state to form such a general partnership. However, it is usually best to file and to draft formal agreements. In fact, those actions are necessary if you want to limit your liability.
One of the biggest drawbacks for partnerships is liability of the partners. With general partnerships, every partner is liable for the debts, obligations, and other liabilities of the partnership. This means that if the partnership is sued and found to owe money to a third party, the third party can collect that money from the company and also from the personal assets of each of the partners.
There are certain forms of partnerships, namely limited partnerships, under which certain partners can avoid such liability. But you should always speak to an attorney knowledgeable in partnership law before assuming you can avoid liability as a partner.
Basics of Partnership Taxes
We can write volumes on partnership taxation, but we won’t bore you with all of the details of this area of the law.
However, it is important to note that partnerships are considered a “pass-through” entity. This means that the partnership itself doesn’t pay income tax because all income, losses, deductions, and the like are passed through to the individual tax returns of the partners. Each partner will recognize his or her proportionate share of those items based on his or her partnership interest. Further, partners are not paid like most employees. Rather, they are paid using guaranteed payments and partnership distributions, both of which require the partner to pay his or her own self-employment taxes (the partnership doesn’t withhold taxes for those payments).
As with other business entities, it is important to have the proper documents drafted for your partnership. The most important being the Partnership Agreement. This agreement will outline all of the important issues for the partnership such as how to add or remove a partner, how money is distributed, and how decisions are made. These agreements can be short, but they are usually long and range from 10-15 pages to well over 50 pages.
Consult with a Business Entity Attorney Today
Before you make the decision to operate your business as a partnership, it is in your best interest to consult with a legal professional who knows the intricate details of business entity law. Together, you and your attorney can explore which business entity model is the right choice for you.
At Krigel & Krigel, we have many business attorneys that can help you. You can learn more about our business practice group and its attorneys on the business law page at krigelandkrigel.com.
*This article is very general in nature and does not constitute legal advice. Readers with legal questions should consult with an attorney prior to making any legal decisions.