The purpose of an employer identification number (EIN)—also known as a "taxpayer identification number" or "TIN"—is to allow the IRS to track wages and other payments from your business to the business's employees and owners. An EIN is also helpful in establishing a business bank account that's separate from your personal bank account.
Whether you're required to get an EIN for your business depends on how your business is set up. Many businesses must have an EIN. But some businesses—specifically, some single-owner companies—might not be required to get an EIN.
When you don't have an EIN for your company, you instead use your Social Security number (SSN) on your business accounts and government filings.
All C corporations and S Corporations need an EIN.
All general partnerships and limited partnerships need an EIN.
If you have a limited liability company (LLC), then multiple factors will determine whether you need to get an EIN. Many single-member LLCs can simply use their owner's SSN for IRS purposes. But if your LLC will hire employees—or if it'll have multiple members—you need to apply for an EIN for the LLC. Below are the details.
Multiple-member LLCs. If you're forming an LLC with multiple members, your LLC will need to obtain an EIN from the IRS, whether or not you have (or will eventually hire) employees.
Single-member LLCs with no employees. If you're forming a single-member LLC and you don't plan on hiring employees (and you won't have a Keogh plan or run a trucking, transport, or similar company that will owe federal excise taxes), you don't need to apply for an EIN for your business. You can use your own SSN for federal tax purposes (don't worry, you won't need to use your SSN on any public documents). However, know that some lenders and banks that you do business with might require you to have an EIN. You can always get an EIN for your LLC if you wish, either to make doing business with banks easier or just to separate your personal finances from your business's finances as much as possible.
If you're converting a sole proprietorship to an LLC and you already had an EIN for your sole proprietorship, you can use that one for your LLC, as long as your LLC doesn't have employees.
Single-member LLCs with employees. If your one-member LLC plans on hiring employees in the next 12 months, your LLC will need to apply for an EIN. In this case, the IRS might actually assign you two EINs: one for the LLC and one for you, the sole owner. Employment taxes must be reported under the LLC's EIN, and any monies paid from the LLC to the LLC member must be reported under the member's EIN number.
Note that if you're converting your sole proprietorship to an LLC and you've hired (or plan on hiring) employees, but you already have an EIN, you might need to apply for another EIN. Any monies paid from the LLC to you as sole owner must be reported under your EIN as owner. Employment taxes must be reported under the LLC's EIN.
For more guidance, check out our article about when a single-member LLC needs an EIN.
If your LLC elects to be taxed as a corporation. If your LLC elects corporate-style taxation, it'll need to apply for an EIN.
As a sole proprietor, your EIN requirement will depend on whether you have employees.
If your sole proprietorship won't have employees. If you don't plan on hiring employees (and you won't have a Keogh plan or run a company that will owe federal excise taxes), you don't need to apply for an EIN. You can use your own SSN for federal tax purposes. (You won't need to use your SSN on any public documents.) But keep in mind that some lenders you do business with could require you to get an EIN for your business.
If your sole proprietorship will have employees. If your business plans on hiring employees in the next 12 months, you'll need to apply for an EIN.
You can apply for an EIN for any business—regardless of whether it's required. If you plan to have an EIN in the future (perhaps you're considering hiring an employee, but not quite yet), it's a good idea to submit your application now to avoid the hassle of changing account numbers later. An EIN allows you to keep your personal information safe. Without an EIN, you'll use your SSN on your business filings and accounts.
An EIN might benefit your business financially. When reviewing loan applications, some lenders prefer to see an EIN rather than a SSN. Having an EIN also allows you to build the business's credit score, which is separate from your personal credit score. A strong business credit score can lead to better interest rates and loan opportunities.
For single-member LLCs, an EIN can help maintain the personal liability protection for the owner that the single-member LLC normally provides. The added protection is helpful when a court is considering whether the LLC owner treated the business like a sole proprietorship or as a separate business entity. If a judge decides the former, the judge might hold the owner personally responsible for the debts and obligations of the business. While an EIN is no guarantee that liability protection will always result in intact liability protection, having the number is a simple step to take to decrease the likelihood of losing protection.
You can apply for an EIN from the IRS in various ways. The easiest way to apply for an EIN is online through the IRS website. If you apply online or by phone, you'll receive your EIN immediately. For more detailed instructions, read our article on how to get an EIN.
In most cases, you'll be able to figure out whether your business needs an EIN. However, your circumstances might be complicated. Or, you might not be required to get an EIN but you want advice on whether it makes sense for your business. In these instances, it might be a good idea to talk with a business attorney. A lawyer will help you work through your options and advise you on your legal obligations to the IRS.
]]>You and your co-owners should draft a buy-sell agreement—also known as a “buyout agreement”—to lay out the rules and procedures to follow when one or more owners leave.
A buyout agreement protects business owners when a co-owner wants or has to leave the company and protects the owner who's leaving. If a co-owner leaves, a buyout agreement acts as a sort of "premarital agreement" to protect everyone's interests—setting the price and terms for a buyout.
Every day that value is added to a business without a plan for future transition, the owners' financial risk increases. An agreement will reduce uncertainty and can help avoid uncomfortable negotiations between the owner who leaves and the owners who remain.
Additionally, if a company doesn’t have a buy-sell agreement in place, it’s at the mercy of its state’s laws. Your state’s laws might not correspond with the future you or the other owners see for your business. For instance, some states require a partnership to dissolve when a partner leaves. If you don’t want the default rules of your state to decide your business’s fate, you’ll need an agreement that says what’ll happen.
A buy-sell agreement can be either a separate agreement or a section within a company’s governing document. This agreement is a legally binding contract among a business’s owners that provides the rules and procedures for:
Let’s take a closer look at each of these buyout agreement topics.
Broadly speaking, there are two situations in which an owner will leave a company. Either the owner will voluntarily leave or be forced out—either by the other owners or by outside circumstances.
An owner might decide to leave for different reasons such as:
Typically, a buy-sell agreement will provide rules for how and when the owner must provide notice of their intent to leave to the other owners. Everyone will hopefully walk away relatively pleased.
But sometimes an exit is a little messier—particularly when the owner is being forced to leave the company. A buy-sell agreement usually lists circumstances that will “trigger” a forced buyout that requires an owner to give up their share of the business.
These circumstances usually include:
When an owner is forced to give up their ownership in the company, they might put up a fight. Having a buy-sell agreement that clearly lists out the circumstances that require an owner to surrender their interest can help eliminate much of the back-and-forth between the owners.
In addition to covering the circumstances under which an owner can or must leave the company, your buy-sell agreement should address who can buy the departing owner’s interest.
Generally, you have three options for who can buy the departing owner’s share:
Your agreement should specify who can or must buy the business. Many companies will require the departing owner to first offer their interest to the other owners or to the company in what’s known as the “right of first refusal.” Then, if the other owners or the company decide not to purchase the interest, the departing owner can offer their share to someone outside of the company.
When creating a buy-sell agreement, you and your co-owners should decide which option would work best for you. With larger companies (particularly corporations with shareholders), it might not be as important to require owners to offer their share back to the company or other owners. With smaller companies where the owners are actively running the business together—like partnerships and limited liability companies (LLCs)—it often makes sense to require the departing owner to offer their share to the other owners.
If you require the departing owner to offer their company share back to the other owners or to the business, you should specify whether the other owners or the company have to buy it. Requiring the other owners or the business to buy the share simplifies and speeds up the buyout process. On the other hand, not requiring the purchase can open the business and its owners to outside business opportunities.
An owner is leaving the business and you’ve established who can purchase their share. But how do you determine how much money should the departing owner get for their share?
It can be hard to settle on a price in a buy-sell agreement before your business has even gotten off the ground. You probably don’t know how successful the business will be or what its true value is.
Fortunately, you don’t have to put a specific value on the price of an owner’s share if you don’t want to. Instead, your buyout agreement can state that the value of an owner’s share will depend on the company’s value.
Usually, the price for an owner’s share is determined by:
Once you put a price on the business’s value, you can calculate the departing owner’s buyout share. Usually, the departing owner will receive an amount proportional to their ownership share. For example, if a business is valued at $100,000 and the departing owner owns 30% of the business, they’d probably receive $30,000 for their share.
But an owner’s buyout can depend on other factors that the owners have agreed to. For instance, sometimes an owner’s distribution (profit) share doesn’t equal their ownership interest. Likewise, an owner’s buyout price doesn’t have to match their ownership interest.
When an owner leaves, what becomes of the company? Generally, there are two outcomes: the company ends (dissolves) or continues. While the answer might be obvious to some, it’s still worth spelling out in the buy-sell agreement.
Usually, whether the business should end or continue after an owner departs depends on the company’s business structure. For corporations and LLCs, the company usually continues on without the owner or with a new owner in their place. LLCs and corporations are more resilient to ownership changes. With their limited liability and flexible management structures, it’s usually not hard to find an immediate or eventual replacement owner.
For example, suppose Buzz, Woody, and Andy own the LLC, Pizza Planet, LLC. For the pizza joint, Buzz develops the recipes, Woody takes care of the marketing, and Andy handles the accounting. One day, Andy decides to retire and sells his share of the company back to Woody. Instead of the company ending, Buzz and Woody can hire an accountant to take over Andy’s responsibilities and business can go on as usual.
But for general and limited partnerships (and limited liability partnerships), a partner’s withdrawal can mean the end of the company. Some partnerships require their company to wind up and dissolve if a general partner exits because a general partner’s role in the business is so critical to the business’s operations.
For instance, returning to our Pizza Planet example, now suppose Buzz is a general partner and Woody and Andy are limited partners who don’t help run the business. Buzz decides to retire. Because Buzz made the pizza and managed the staff—and was the face of the restaurant—it’d be difficult for Woody and Andy to carry on the business without him.
If you don’t include what happens to your business when an owner exits, your state’s laws will step in to provide the answer. Be sure to include this determination to avoid your business prematurely ending.
Buyout agreements can be for any business with more than one owner. The main types of buy-sell agreements are:
While these buyout agreements all contain many of the same elements, they can differ in their rules and procedures. For example, a shareholder buyout agreement might provide a different method for determining a share’s value than a partnership buyout agreement. Or different events might trigger an LLC owner buyout than a shareholder buyout.
As mentioned earlier, a buy-sell agreement might actually appear as a provision within the company’s governing document. If you want to take this route, business owners often put a buyout provision in one of the following documents:
As you’re negotiating your buy-sell agreement with your co-owners and considering the potential issues that might crop up down the road, you might have a few questions.
In some states, yes, and the former spouse can succeed in getting it, too. In community property states, all earnings during marriage and all property acquired with those earnings are considered community property—owned equally by husband and wife. When property is divided during a divorce, each spouse can claim a right to all community property. So, if the owner’s business share is considered community property, their former spouse might have a claim on it.
Even in non-community property states, a spouse could argue for a partial interest in the business, because marital property laws generally require property to be divided equitably during divorce.
To avoid this prospect, a good buy-sell agreement requires the former spouse of a divorced owner to sell any interest received in a divorce settlement back to the company or the other co-owners. The ex-spouse will usually be compensated based on the valuation method specified in the agreement.
Potentially. In the worst-case scenario, a bankruptcy trustee, who’s appointed to oversee and manage the bankruptcy, could liquidate the business (sell its assets) to pay the bankrupt owner's debts. However, usually, a trustee can usually only sell the entire business if it’s structured as a partnership and the trustee has the court’s permission. Otherwise, typically only your share of the business is at stake.
Regardless of your business structure, to head off the possibility of your company getting tied up in bankruptcy court, the owners can sign a buy-sell agreement that requires a co-owner who faces bankruptcy to notify other co-owners before filing. Usually, under the terms of this agreement, the owner filing for bankruptcy must sell their interest in the company back to the other owners before they file. After severing ties with the owner, the business can proceed.
Requiring an immediate 100% lump-sum cash payout can prevent even the most successful company from buying back a departing owner's interest. Having flexible payment terms built into a buy-sell agreement, created in advance, can help.
For instance, the agreement can provide for a down payment of 20% to 30% of the buyout price. The remaining amount can be paid out in installment payments for three to five years at a reasonable rate of interest defined or specified in the agreement.
Separately, it’s common for a company or its owners to take out life insurance policies on each owner. Assume the co-owners of a business have taken this step, naming either the business or its owners as the beneficiaries of the policies. If one owner dies, their share of the business passes to their heir or estate. But the company gets life insurance proceeds that it can use to purchase the deceased owner’s company share. Again, the procedure for this type of buyout would need to be included in the buy-sell agreement.
In the past, family or intergenerational businesses (like family LLCs) sometimes successfully used buy-sell agreements to lower (or altogether avoid) estate taxes when an owner died. An intergenerational business is one where at least one co-owner plans to leave their interest to heirs who will remain active in the business.
The key to this estate planning strategy was to choose a conservative price or valuation formula for the business in the buy-sell agreement. The IRS then used that relatively low valuation when calculating whether federal estate tax was due, and how much.
But for buy-sell agreements entered into or modified on October 9, 1990 or later, the rules are more stringent. For example:
(26 U.S.C. § 2703.)
In other words, there’s no longer as much leeway in valuing the family business to avoid estate tax.
Fortunately, not many people need to worry about federal estate tax. In 2023, only estates worth more than $12.92 million ($25.84 million for married couples) will trigger the federal estate tax. (In 2026, if no further legislation is passed, this threshold amount is set to essentially halve, but it’s still a fairly high threshold for most Americans.) Some states also impose separate state estate taxes at a lower threshold, but the tax rate is much lower than the federal estate tax.
If it seems likely that you’ll owe estate tax when you die, consult a business attorney who’s experienced with estate tax. And if you already have a buy-sell agreement dated before October 9, 1990, think twice and consult an attorney before modifying it, since you risk losing some of the valuation leeway that still applies to these older agreements.
Yes. You should have a short sentence in your agreement that says the agreement can be changed by a written amendment with the owners’ approval. As your business grows or new owners join, you might notice issues or opportunities you missed before. You’ll want to have an agreement that you can reasonably change to reflect these new discoveries.
For example, suppose the ROFR clause in your agreement doesn’t apply when an owner dies, meaning a deceased owner’s heirs can join your company as owners. One of your co-owners dies and leaves their interest to their nephew who immediately starts making poor management decisions, putting the business into serious debt. You might want to alter your agreement to have the ROFR clause extended to the owners’ estates so you can avoid this kind of situation in the future.
If you’re starting a business and you’re looking to create a buy-sell agreement, talk to your co-owners. You’ll need to sit down with them and discuss the terms of the agreement. In all likelihood, this conversation will be much friendlier now than when someone leaves. If you and the other owners are on the same page about most or all of the buyout terms and you have some experience writing legal agreements, you can probably draft a buy-sell agreement yourself.
If you’re interested in further guidance and in a buy-sell agreement that you can fill in, check out Business Buyout Agreements: Plan Now for All Types of Business Transactions, by Bethany Laurence & Anthony Mancuso (Nolo).
If the owners are in disagreement or you’re not sure which terms are best for your particular situation, you should consult a small business attorney. They can help you negotiate terms with your other owners and draft an agreement for you. They can also advise you on the potential tax implications of your buyout agreement and suggest alternative terms to the ones you’re considering.
]]>To guide you through the dissolution and winding-up process, you need to look at your partnership agreement, Texas partnership law, and best practices. Following these steps can help limit your liability and legally end your obligations.
Texas partnership laws are relatively unusual. So, you should consider consulting with a local business attorney before ending your partnership. For general guidance, see our article on dissolving a partnership to end your liability.
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Before dissolving and winding up your business, your first task is to check your partnership agreement. While Texas doesn’t require partnerships to have an agreement, many partners create one when they form their partnership. If you don’t have a preexisting partnership agreement, the default provisions of Texas partnership laws will apply.
Your partnership agreement can provide the procedures for a dissolution vote as well as instructions for how partnership assets will be sold off and used to pay the company’s debts.
But your agreement might not cover everything. If there’s anything that the partners need to resolve, they should do so now. You can amend your partnership agreement or create a separate partnership dissolution agreement with the new terms.
Partnership agreements often provide two ways for partnerships to be dissolved: by vote or by written consent without a vote.
In addition to providing ways the business can be dissolved, your agreement should also give the minimum number of partners needed to authorize the dissolution. For example, your agreement might require the following minimums:
A “majority-in-interest” generally means that the partners who vote in favor of the dissolution must, when their interests are combined, have at least a 50% interest in either:
For instance, one partner with a 30% ownership interest and another partner with a 25% ownership interest would together be considered to have a majority in interest. Because their combined interests in the partnership equal 55%, together they have at least 50% of the ownership interest.
Some partnership agreements might require a different minimum based on how the matter of dissolution comes up. For example, if the partners vote at a meeting, the partnership agreement might only require two-thirds of the partners to vote in favor of dissolution. But if the partners don’t have a meeting, the agreement might say that the partnership can be dissolved only by unanimous written consent of the partners.
If you and your partners don’t agree on how to dissolve the business—or on whether you should dissolve the business at all—then you’ll need to reach a resolution. Fortunately, you usually have a couple of options to resolve these types of disputes:
Ultimately, however, if the partners can’t come to an agreement after trying other options, you’ll have to fall back on going to court and getting a judge to decide how the dissolution will proceed. You should try to avoid going to court. But if you really have no choice, you and your fellow partners should be independently represented by lawyers.
If you don’t have a partnership agreement, you’ll have to rely on the state partnership laws. In general terms, Texas law says that dissolving and winding up a partnership requires the express will of a majority-in-interest of partners who still have a partnership interest. (Tex. Bus. Orgs. Code § 11.057 (2023).)
For example, suppose Charlie, Connie, and Russ are partners in Bombay Ice Company in Texas, and their business doesn’t have a partnership agreement. Charlie owns 60% of the partnership, and Connie and Russ each own 20%. Under Texas law, Bombay Ice Company can be dissolved by the vote or consent (express will) of Charlie alone—even if Connie and Russ vote against dissolving the partnership. Though Charlie is just one-third of the people in the partnership, he owns 60% (a majority-in-interest) of the company.
You should be able to meet Texas’s dissolution requirement by having the partners with ownership interests that total more than 50% vote in favor of a written resolution to dissolve and wind up the partnership.
Texas doesn’t require general partnerships to file a form with the state when they dissolve. Because general partnerships are considered “unincorporated,” you don’t need to file any paperwork with the Secretary of State (SOS) to form or end your partnership.
After you’ve voted to dissolve, you need to start the process of winding up the partnership. You’ll want to finish up—or assign—any contracts currently in progress. You should also “liquidate” (sell) your partnership’s physical assets like land, buildings, vehicles, and equipment.
Next, you should settle partnership debts before distributing the remaining assets to the partners. Texas has rules about the order that people must be paid in when winding up a partnership. In general, creditors, including partners who are creditors, must be paid first. If there’s any money left over, it must be distributed to the partners according to the partners’ capital accounts. (Tex. Bus. Orgs. Code §§ 152.706-707 (2023).)
A partner’s capital account is the partner’s balance with the partnership. If there’s a positive balance, the partnership owes the partner money. If there’s a negative balance, the partner owes the partnership money. If the partner contributes money to start up the business, then their capital account will begin with the amount they contributed because that’s how much the partnership would owe them. Otherwise, their capital account balance would usually start at zero.
The account should then fluctuate throughout the life of the partnership based on the partner’s share of the business income and any distributions made to the partner. Once the partnership dissolves, the money the partnership makes or loses from selling its assets and paying its debts should factor into the partner’s final capital account balance.
(To learn more about capital accounts, read our partnership FAQ.)
Suppose that Tia, Tamera, and Roger are all partners in Sister-Sister Productions, and they’ve agreed to share in the business’s profits and losses equally. The three partners decide to dissolve the business and start winding up its affairs. After paying all its creditors, the partnership has $8,000 to distribute to its three owners. The partners have the following capital account balances:
When added together, the partners’ capital accounts equal $20,000. So, the partnership has a debt of $20,000 to its partners. Because the business has $8,000 in assets and $20,000 in liabilities, the partnership’s total obligations (debt) would be $12,000. The partners share in the business’s profits and losses equally (one-third each), so each partner would be responsible for $4,000 (one-third of $12,000) of the partnership’s total debt.
To calculate the total amount that they should receive from the partnership, each partner would simply subtract the $4,000 they’re responsible for from their capital account balance. So, the partners would be entitled to the following amounts:
The above example is based on three partners who share equally in the partnership’s profits and losses. Your partnership agreement can provide a different distribution scheme. For example, one partner could be entitled to 60% of the profits and another partner could be entitled to 40%. However you choose to divide up the partnership interests, a partner’s capital account should always reflect a partner’s share of the business’s assets.
While not a legal requirement, you should notify creditors, customers, and others that your partnership is dissolving. Providing notice can help limit your liability for unknown debts and prevent partners from entering into unauthorized business deals.
You can send a written notice directly to creditors, business associates, and customers through the mail or by email. The notice can be specific to the recipient. For example, notice to a creditor can provide information on how and where they can send you information about their claim. Otherwise, the notice can be general, such as in a newsletter.
You can also simply post an announcement on your company website, social media pages, or physical place of business. Many companies publish a notice for a week or two in a local newspaper.
Make sure you keep a record of any notice you provide, especially notices to creditors.
As a partnership in Texas, you have few tax obligations. You’re not required to obtain tax clearance before dissolving or winding up.
In addition, general partnerships whose partners are all natural persons (not companies) aren’t responsible for paying the state’s franchise tax. (However, general partnerships that elect limited liability, for example as a limited partnership or limited liability partnership, are liable for the franchise tax.)
State and federal income taxes. Texas doesn’t have a personal income tax so the partners won’t need to pay taxes on their share of the partnership’s profits. For federal tax purposes, your partnership must file IRS Form 1065 and each partner will need to report their earnings share on their individual federal returns. If your partnership dissolves before the end of its normal tax year, its final federal return is due by the 15th day of the third month following the termination date.
Other state taxes. While you don’t have to pay income tax and your partnership doesn’t have to pay a franchise tax, you could still be responsible for reporting and paying other state taxes. Specifically, depending on your business activities, you might need to pay sales and use tax and property tax. You can find the appropriate tax forms on the Texas Comptroller of Public Accounts website.
The last step to winding up your business is closing out any remaining accounts, including bank accounts.
Additionally, if you have any of the following on file with a state or local government, you should cancel them:
In the end, there should be nothing left in your partnership’s name.
You should generally have a good idea of how to dissolve and wind up your Texas business partnership. But every business is different and you might have specific legal considerations that you’d like additional information on. For more, detailed guidance, read our 20-point checklist for closing a business. The Texas SOS also provides a frequently asked questions page about terminating a business entity.
If you need legal assistance, consider reaching out to a business attorney. They can help you through every step of the process, particularly when it comes to asset distribution.
]]>To end your business, you’ll need to follow New York partnership laws, your partnership agreement, and best practices. Taking legal steps to close down your business will help limit your liability and give you a clean break.
For more general guidance, see our article on dissolving a partnership to end your liability.
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Before you start the process of dissolving your business and winding up its affairs, you need to check your partnership agreement. While a written partnership agreement isn’t required in New York, you and your partners probably would’ve prepared an agreement when you first formed your partnership or at some later point in time. If you never made a partnership agreement, you’ll have to abide by the default provisions of New York state partnership law.
The key areas to look for in your partnership agreement’s dissolution provisions are:
Continuing the partnership. A well-written partnership agreement will plan for a case where some partners want to leave the partnership but other partners want to stay and continue running the business. In this case, your partnership agreement—or a separate buy-sell agreement—might include a provision where partners can buy out the partnership interests of the partners who want to leave.
Amending the partnership agreement. If situations arise that aren’t covered in your partnership agreement, you should figure out how to handle them now. You should put any terms in writing.
Typically, partnership agreements will provide ways for the partners to officially dissolve the business. Often times you can dissolve the partnership by vote or by written consent. Your partnership agreement should also specify how many partners are needed to authorize the dissolution, such as:
The threshold you choose might depend on whether there’s a vote at a meeting. For example, your agreement might require that the dissolution be approved by two-thirds of the partners if there’s a vote at a special meeting. Your agreement might also allow the partnership to be dissolved without a meeting as long as all partners give their written consent. In either case, you should draft a resolution to dissolve the partnership for the partners to consider and take action on.
If you don’t have a partnership agreement, you’ll have to rely on New York partnership law. The law says that a partnership can be dissolved in a number of ways, including the bankruptcy or death of a partner. But a partnership can also be dissolved by the express will of any partner at any time as long as this method either:
(N.Y. Partnership Law § 62 (2023).)
Usually, a partner can dissolve a partnership by providing written notice of their intent to dissolve to the other partners.
In New York, general partnerships aren’t required to file any paperwork with the Department of State when they dissolve.
Once your partnership has been dissolved, you’ll need to complete some additional tasks to wind up the business, including paying debts and distributing assets to the partners. Before you can pay your debts and distribute assets, you’ll need to sell off any property the partnership has, such as real estate, vehicles, equipment, and inventory.
After your partnership has liquidated its assets, you should have money available to pay creditors. New York partnership law has rules for what order people must be paid in when winding up a partnership. In general, the rules are:
(N.Y. Partnership Law § 71 (2023).)
For example, suppose Jesminder and Juliette have agreed to dissolve their partnership, Bend It Soccer. The partnership has $100,000 to pay creditors and distribute to its owners. Bend It Soccer owes $50,000 to the bank for a mortgage and $10,000 to Jesminder to cover an equipment loan. To start the business, Jesminder contributed $15,000 and Juliette contributed $5,000. Jesminder and Juliette have agreed to share in the profits equally. Under New York law, the partnership’s $100,000 in assets would be distributed in the following order:
When paying your debts, you should try to negotiate a settlement with your creditors for an amount that’s less than what you owe. If you reach an agreement with any creditors, make sure you put the terms in writing.
New York law says that all of the partners are jointly responsible for taking care of the debts. So, if the partnership doesn’t have enough money to cover its obligations, the partners will be responsible for coming up with the rest of the cash. (N.Y. Partnership Law § 26 (2023).)
You should also have some agreement with your partners about each partner’s responsibility to pay for debts. Your partnership agreement can specify the percentage of debt each partner is responsible for. Typically, the percentage of profits a partner receives is the same as the percentage of debt the partner is responsible for. For example, your partnership agreement might say that Partner A is entitled to 20% of the profits and obligated to pay 20% of the partnership’s debt.
While not legally required, you should reach out to creditors, business associates, customers, and others to let them know that your partnership is dissolved. For any known debts, you should contact those creditors directly by phone, letter, or email.
You can notify unknown creditors and everyone else with:
You should keep copies of these notices.
New York doesn’t require you to receive a tax clearance letter or certificate before dissolving or winding up your partnership.
However, the state’s Department of Taxation and Finance (DOTF) does advise you to take care of the following tax matters when closing your partnership:
For information on filing a final sales tax return, check Tax Bulletin ST-265, which you can find in the guidance section of the DOTF website.
State personal income taxes. General partnerships are considered “pass-through entities,” meaning the owners report and pay taxes on their share of the partnership’s income. As a partner, you’ll need to report and pay taxes on your share of the partnership’s income. While you still need to report your partnership earnings, the business itself doesn’t need to pay taxes on its income.
Federal income taxes. Your partnership must file IRS Form 1065 and check the “final return” box. Under IRS rules, if your partnership terminates before the end of its normal tax year, the final federal return is due by the 15th day of the third month following the termination date.
If you have anything left belonging to your partnership, make sure you close it out. You should close or cancel the following:
You might be able to sell or transfer some permits and licenses. You should check the transferability of these licenses and permits as you’re liquidating partnership assets.
Dissolving and winding up your partnership is only one piece of the process of closing your business. For further, detailed guidance on many of the other steps involved, check out our 20-point checklist for closing a business.
You can probably dissolve and wind up your partnership on your own, especially if you don’t have many assets to liquidate or debts to settle. But if you run into issues during the dissolution process, like problems with creditors or disputes among partners, you should talk to a business attorney. An experienced lawyer can walk you through the process and make sure you legally end your obligations and protect your interests.
]]>Following your partnership agreement, Florida partnership laws, and best practices can help limit your liability during the closure of your business. For general guidance, see our article on dissolving a partnership to end your liability.
Table of Contents
The first step in dissolving your partnership is to check your partnership agreement if you have one. Many partners draft a partnership agreement when they form their partnership. If you never created an agreement or your agreement doesn’t include dissolution provisions, then you’ll need to follow the default rules and procedures set out in Florida’s Revised Uniform Partnership Act (RUPA).
Your partnership agreement should provide a procedure for how to end your business, including the vote required to dissolve and the forms you should file with the state. It should also give instructions for how your partnership should handle its assets, including:
Your partnership agreement should cover most, if not all, matters related to dissolution. But if anything isn’t covered, you and your partners should come to an agreement about how to proceed. You can amend your existing agreement or draft a partnership dissolution agreement to cover these additional terms.
If you have a partnership agreement with dissolution provisions, you should follow what’s laid out in the agreement. Usually, partnership agreements provide multiple methods for dissolving a partnership, such as:
Your agreement should provide a minimum threshold for passing the resolution to dissolve the partnership. For example, your agreement might require half, two-thirds, or all of the partners to vote in favor of dissolution for the resolution to pass. The threshold you choose might depend on a number of factors, including:
If you don’t have a partnership agreement, then you’ll need to follow the default rules in Florida’s RUPA. In Florida, a partnership can be dissolved if any partner decides to leave the partnership unless the remaining partners elect to continue the partnership without the disassociated partner. (Fla. Stat. § 620.8801 (2023).)
Under Florida law, a partnership can continue when one or more partners want to leave. Partnership agreements often provide partners with the same option. Partnerships can include buyout provisions—also called “buy-sell provisions”—in their partnership agreement that define when a partner’s share can be bought out, for how much, and by who. If you don’t have a partnership agreement or your agreement doesn’t include these provisions, you can negotiate a separate buyout agreement.
Florida doesn’t require partnerships to file any forms with the state when they dissolve. General partnerships are considered “unincorporated” so you don’t need to file a form with the Department of State (DOS) to create or end your partnership.
Though not required, it’s still a good idea to file a Statement of Dissolution with the DOS’s Division of Corporations (DOC). Filing this dissolution document can limit your liability and make it clear your partnership has ended. Specifically, the Statement of Dissolution cancels a filed statement of partnership authority and limits the partners’ authority to bind the business to transactions, like selling the partnership’s real estate. (Fla. Stat. § 620.8805 (2023).)
You can only file this form if you’ve already filed a partnership registration with the DOC. In your Statement of Dissolution, you’ll need to provide:
You’ll need to give the partners copies of the filing as well. Under Florida law, other people generally are considered to have notice of the partnership's dissolution 90 days after filing the Statement of Dissolution. (Fla. Stat. § 620.8805 (2023).)
As of 2023, the filing fee is $25. You can find general partnership forms for download on the general partnership forms section of the DOC website. You’ll need to mail the completed form to the DOC.
After the partners have decided to dissolve the partnership and you’ve filed the appropriate forms with the state, you can begin winding up the business. To wind up the business, you’ll need to:
You’ll need to pay all debts before dividing the assets among the partners. Florida's partnership law has rules for what order people must be paid in when winding up a partnership. In general, creditors, including partners who are creditors, must be paid first. Then any surplus must be distributed to the partners according to their partnership accounts. (Fla. Stat. § 620.8807 (2023).)
A partnership account (also known as a “capital account”) reflects a partner’s running balance with the partnership based on how much the partner contributed to and received from the partnership. So if the partner’s balance is negative, they owe money to the partnership; if their balance is positive, the partnership owes them. (To learn more about capital accounts, read our partnership FAQ.)
For example, suppose Carlos and Sonia have agreed to dissolve their partnership. The business has $50,000 to distribute to the partners after paying creditors. Carlos has a balance of $30,000 in his partnership account and Sonia has a balance of $20,000. So, Carlos would get $30,000 of the partnership’s $50,000 and Sonia would receive the rest. Carlos and Sonia’s partnership accounts would reflect:
(Fla. Stat. § 620.8401 (2023).)
Your partnership agreement should determine each partner’s share in the business’s profits and losses. Usually, a partner’s profit share is the same as their ownership interest in the business. If you don’t have a partnership agreement or the agreement doesn’t specify the partnership shares, then Florida law says that each partner is entitled to an equal share of the partnership profits and responsible for an equal share of the partnership losses. (Fla. Stat. § 620.8401 (2023).)
When the partnership is left with debt. After liquidating company assets and paying creditors, the partnership might not have any money left to distribute to the partners, or worse, it might owe money. In Florida, unless the partnership agreement says otherwise, the partners share equally in the debt burden. So, if you have $10,000 in partnership debt and two partners, each partner would have to personally pay $5,000 to cover the business debt.
Negotiating with creditors. When paying your debts, you should try to negotiate a settlement with your creditors for an amount that’s less than what you owe. Limiting the partnership’s debt means that the partners will have to pay less out of their own pockets—and it could even mean putting some money back into the partners’ pockets. If you reach an agreement with any creditors, make sure you put the terms in writing.
In Florida, you’re not legally required to notify creditors or others about your partnership’s dissolution. But it’s a good idea to give notice anyway. For example, suppose that after dissolution, a partner tries to sign a business deal on behalf of the partnership. But the other party to the deal knows that the partnership has dissolved. In that case, the business deal likely can’t be enforced against the partnership.
In Florida, filing a Statement of Dissolution provides notice of the partnership’s dissolution to creditors (and anyone else) 90 days after filing. (Fla. Stat. § 620.8805 (2023).)
If you don’t file a dissolution statement or want to provide additional notice, you can announce your partnership’s dissolution in a local newspaper. You can also create a post on your company website or social media page. If you have any creditors, it’s a good idea to reach out to them directly to let them know your business is dissolved.
Keep a record of these notices, including when and where the notices were posted.
In Florida, you don’t need to obtain tax clearance before dissolving or winding up your partnership.
However, you must notify the Department of Revenue (DOR) that you’re closing your business. The DOR prefers that you submit this information using their online eServices system. The system also can be used to close a sales tax account, reemployment tax account, and other business-related tax accounts. You’ll need to be enrolled to use the system.
State personal income taxes. For tax purposes, partnerships are considered “pass-through entities.” So, the business itself doesn’t pay taxes. Instead, the income passes through to the partners, who report and pay taxes on their share of the profits. However, Florida is one of the few states that doesn’t tax personal income. So the partners don’t need to pay income tax.
Federal income taxes. For federal taxes, submit IRS Form 1065 and check the “final return” box. If your partnership terminates before the end of its normal tax year, the IRS requires you to file your final federal return by the 15th day of the third month following the termination date.
Other state taxes. While you don’t have to pay income tax in Florida, you might be responsible for reporting and paying other business taxes. You can find information specific to different types of business taxes, including a link to frequently asked questions, on the taxes and fees or refunds section of the DOR website.
At this stage, you should’ve paid your taxes, settled your debts, and distributed any remaining funds to the partners. Your partnership’s bank account balance should be at zero. It’s time to close that account, along with any other open accounts under your partnership’s name.
During your business operations, you might’ve been issued business licenses, permits, or registrations. You might be able to transfer or sell some of these licenses or permits. Otherwise, you should notify the appropriate state or local government to cancel them.
If your partnership operated under a fictitious name (also called a “DBA”) and you registered that name, you should cancel that registration as well.
Closing your business can be a long process with a formidable list of tasks to complete. If you want additional help sorting through the list of obligations, you can read our 20-point checklist for closing a business.
While the list of to-dos might be long, many partnerships can dissolve and wind up their businesses on their own. If you don’t have many assets to sell, debts to pay, or tax forms to file, then you can probably terminate your partnership on your own. But there are some cases where you could need legal assistance, such as when you need help negotiating with creditors, settling disagreements between partners, or filing tax returns. If you need legal advice, speak with a local business attorney. They can help you dissolve and wind up your business—in a limited or complete capacity.
]]>While you can form a partnership without formally filing or registering the entity, partnerships must comply with licensing and tax requirements that apply to all businesses. In addition, every partnership can benefit from a partnership agreement and business insurance.
Here are the basic steps to forming a partnership:
To learn more about partnerships (including the difference between a general partnership and a limited partnership), see our section on partnerships.
For information on your state’s registration requirements, check out our state guide on starting a business.
In most states, partnerships can use either the last names of the individual partners or a trade name (also known as a "fictitious business name," an "assumed name, " or a “DBA”). If you plan to use a trade name, it can’t be the same as or too similar to any name that’s already registered with the state.
For example, suppose Joey Potter and Dawson Leery want to open a seafood restaurant called “Capeside Core Four Eats.” But there’s already another seafood restaurant a few blocks away called “Capeside’s Four Core Eatery.” Because Joey and Dawson’s restaurant would have a very similar name to the restaurant that already exists, they should probably choose a different name.
Before you land on a business name, you should make sure it’s available for you to use. For example, you can search the following state databases for registered business names:
For tips on choosing a unique and legally compliant business name, check out our FAQ on choosing a business name.
You can't use a trade name to sell your services or goods until you fulfill your state and local registration requirements. Typically, you must file a name registration with the state or at the clerk’s office in your city or county.
When registering your trade name, you might be required to publish a notice in a local newspaper—your local agency will likely provide a list of approved publications. After the required time for publication (typically around 4 weeks), you must notify the licensing agency that you fulfilled the publication requirement.
Check with your state and city governments for specific requirements.
If you use a business name that’s different from the last names of the individual partners, Florida requires you to register the trade name. In Florida, a trade name is known as a “fictitious business name” (FBN). You must register your FBN with the Division of Corporations before you open for business. (Fla. Stat. § 865.09 (2023).)
You can complete and mail an Application for Registration of Fictitious Name to register your FBN. You can also register online using the FL Fictitious Name Registration.
You’ll need to publish the FBN in a newspaper in the county where you’ll be located. You’ll certify that you’ve published the notice when you apply for your FBN.
As of 2023, the filing fee is $50. You must renew your registration every five years.
If you use a business name that’s different from the legal names of the individual partners, New York requires you to register the trade name. New York refers to a trade name as an “assumed business name.” You must file a certificate of assumed name—often called a “business certificate”— with the county clerk's office in the county where your business is located. (N.Y. Gen. Bus. Law § 130 (2023).)
The appropriate form for filing an assumed business name in New York is available from your county clerk's office. The filing fee varies by county. Contact your county clerk’s office for more information, including the appropriate form and filing fee.
If you use a business name that’s different from the last names or other legal names of the individual partners, Texas requires you to register the trade name. You’ll need to submit an assumed name certificate to the county clerk’s office in the county where your business is located. (Tex. Bus. & Com. Code §§ 71.001 and following (2023).)
Contact your county clerk’s office for information about what form you should file and the associated filing fee. You’ll probably need to renew your certificate every 10 years.
A partnership agreement isn't required to establish a partnership. However, having one is important to avoid misunderstandings between you and your partners. Even well-intentioned, honest partners can find themselves in a legal battle if they don't have a well-drafted partnership agreement.
Here’s a list of some of the items that you should cover in your partnership agreement:
You can always revise your agreement at a later date should circumstances or conditions change. For help drafting your agreement, see our article on creating a partnership agreement.
Partnerships must meet the licensing and tax registration requirements that apply to any new business.
Employer identification number (EIN): The IRS requires every partnership to obtain an EIN, regardless of whether the partnership has employees. An EIN is a nine-digit number issued by the IRS for tax reporting purposes. You can register for an EIN for free at the IRS website.
Business licenses: Your business might need to obtain business or professional licenses depending on the type of business activity you're engaged in. For example, if your partnership offers accounting services, you must comply with state licensing requirements for accountants.
State tax registration: Depending on your state and your business activities, you might be required to report and pay taxes, such as sales tax and use tax. Check with your state’s tax agency for more information and for registration.
Employer registration: If you plan on hiring employees, check the employer registration requirements in your state. In most states, you must pay unemployment and workers’ compensation taxes. For more information about the steps you must take as a new employer, see our article on hiring your first employee.
In addition, local regulations—including licenses, building permits, and zoning clearances—might apply to your business. You’ll need to check with your city and county governments for more information. For additional guidance, read our article about the legal requirements for starting a small business.
Let’s look at some state-specific requirements and resources:
For more information, see our state guide to business licenses.
Because partners of a partnership are personally liable for all debts and obligations of the business, a general business liability insurance policy might be your only financial protection against unforeseen events. Having adequate business liability insurance can protect your business and personal assets if your business is sued.
Your state might require your business to have some forms of insurance, depending on your industry and number of employees. For example, New York requires employers to obtain workers’ compensation insurance, but Texas doesn’t. In Florida, construction businesses with one or more employees and non-construction businesses with four or more employees are required to have workers’ comp insurance.
Additionally, if you use vehicles in your business, almost every state—including Florida, New York, and Texas—requires you to have auto insurance, usually commercial auto insurance.
To learn more about the different policies, read our article on what types of insurance your small business might need.
If you have business experience and face simple legal requirements, you can probably start your partnership on your own. But if you and your partners have any disagreements over how your partnership should be run or you run into obstacles applying for local licenses and registrations, you should talk to a business attorney. They can help you draft a partnership agreement, apply for local licenses and permits, and comply with employment and tax laws.
]]>In California, like every other state, there are no formal filing or registration requirements needed to create a general partnership. However, you must still comply with registration, filing, and tax requirements applicable to any business.
Here are the steps you should take to form a partnership in California:
To read more about partnerships in general—including the difference between a general and limited partnership—see our section on partnerships. (And for information on other California business structures, review our section on starting a business in California.)
In California, a partnership can use the last names of the individual partners or a fictitious business name (FBN)—sometimes called a “trade name” or “DBA” (short for “doing business as”). For example, suppose Dick Grayson and Barbara Gordon form a partnership called “Nightwing Oracle Productions.” The name “Nightwing Oracle Productions” would be an FBN because it doesn’t include “Grayson” and “Gordon,” the partner’s last names (Cal. Bus. & Prof. Code §§ 17900 and following (2023).)
If you plan to use an FBN, it should be distinguishable from (not the same as) the name of any other company currently on record in California. It’s also a good idea to choose a name that’s not too similar to another registered business because of common law and federal trademark law protections. If you start using a name that’s too similar to another business’s name in a way that would confuse customers, you could be sued for trademark infringement and be forced to change your name anyway.
To make sure your proposed business name is available, run a search in the following government databases:
If you’re not sure whether your business name is available to use, consider talking to a trademark attorney. They can tell you the advantages and risks of using your business name, and they can also do a trademark search for you.
If you decide to use a trade name, California requires you to file an FBN statement in the office of the county clerk where you intend to do business. The California State Association of Counties provides a list of county websites where you can obtain more information and forms for filing an FBN statement. (Cal. Bus. & Prof. Code § 17913 (2023).)
Within 45 days of filing your FBN statement, you’ll need to publish the statement in a county newspaper for four weeks. (Cal. Bus. & Prof. Code § 17917 (2023).)
Filing fees vary by county. You’ll need to renew your statement every five years.
A partnership agreement isn’t a mandatory legal requirement for establishing a partnership. However, it’s a very important step to ensure there are no misunderstandings between you and your partners. A well-drafted agreement will help you decide in advance how to handle certain situations.
Here’s a list of some items that should be covered in your partnership agreement:
Even well-intentioned, honest partners can find themselves in a legal battle if they don’t have a written partnership agreement memorializing their initial purposes. Your agreement can always be changed at a later date should circumstances or conditions change. For help drafting this document, see our article on creating a partnership agreement.
Your business might need to obtain business or professional licenses depending on the type of business activity you’re engaged in. For example, if your partnership offers accounting services, you must comply with state licensing requirements for accountants.
California provides a comprehensive database of every profession that requires a license by a partnership. You can find this information by using CalGold, a service of the California Governor’s Office of Business and Economic Development.
In addition, local regulations—including licenses, building permits, and zoning clearances—might apply to your business. You’ll need to check with your city and county governments for more information. For additional guidance, read our article about the legal requirements for starting a small business.
As a business, you have multiple federal and state tax obligations.
Obtain an EIN. Partnerships must obtain an EIN from the Internal Revenue Service (IRS). An EIN is a nine-digit number issued by the IRS to keep track of businesses. If your partnership has employees, you’ll need to report wages to the IRS using your EIN. Registering for an EIN can be done online at the IRS website.
Register as an employer. If you have at least one employee, you must register with the California Employment Development Department (EDD) within 15 days of paying $100 or more in a calendar quarter. You can report and pay all employment-related taxes on a periodic basis using your EDD payroll tax account. The EDD also provides additional information on the different state payroll taxes on its website.
Register to pay sales tax. If you’re a retailer selling goods in California, you need to register with the California Department of Tax and Fee Administration (CDTFA) to pay sales tax. You might need to pay use tax for goods that are stored, used, or consumed in California that aren’t already taxed. You’ll also need to pay local sales tax in addition to state sales tax. You can use the CDTFA online services to register your tax account and apply for a seller’s permit.
You can find additional guidance on partnership taxes and filing requirements on the California Franchise Tax Board (FTB) website. Use the California Tax Service Center to navigate the various tax requirements, including income, payroll, sales, and use taxes.
It is important to consider doing the following once you’ve created your partnership:
If you have business experience and face simple legal requirements, you can probably start your partnership on your own. If you want to do the process yourself but are interested in some help and further education, check out Form a Partnership: The Complete Legal Guide, by Denis Clifford and Ralph Warner (Nolo). This book provides information on important topics like profit distribution and financial and tax liabilities as well as sample partnership agreements.
If you and your partners have any disagreements over how your partnership should be run or you run into obstacles applying for local licenses and registrations, you should talk to a business attorney. They can help you draft a partnership agreement, apply for local licenses and permits, and comply with employment and tax laws.
]]>Business owners often mistakenly interchange the two business structures with the misunderstanding that they’re one and the same. Although these legal arrangements share many similarities, there are significant differences that business owners should be aware of when attempting to form an alliance with another enterprise.
By evaluating the pros and cons of each relationship in advance, you can be empowered to make the best strategic decision for your business.
In order to properly distinguish between a JV and a partnership, it helps to start with the definitions and some simple examples.
A partnership is often described as a voluntary association of two or more people who jointly own and manage a business for profit. Partnerships are usually ongoing relationships defined by a partnership agreement.
For example, suppose two friends fresh out of law school want to join together to start an animal rights law firm. They write up a partnership agreement that divides up their responsibilities and duties as partners in the firm. They’ve started a partnership.
Alternatively, consider a hairstylist and independent accountant who want to combine their respective talents to open a salon. They enter into a business partnership where the hairstylist provides services to clients and the accountant takes care of the salon’s finances.
A JV can be described as a business undertaking by two or more people engaged in a single defined project. The creation of a JV is a question of fact that’s determined by the circumstances.
The necessary elements of a JV are:
For example, Sony Ericsson Mobile Communications was a JV started in 2001 by the Japanese consumer electronics company Sony Corporation and the Swedish telecommunications company Ericsson to make mobile phones. Sony contributed its expertise in manufacturing electronic products and Ericsson contributed its mobile and internet communications services.
These definitions overlap in certain ways. Both JVs and partnerships consist of co-owners of a business enterprise sharing the profits and losses. But these business structures also have key distinctions.
JVs differ in how they’re formed, why they’re formed, and for how long they’re formed.
Formation. Partnerships are established when two or more people enter into business together. This business association is usually evidenced by a partnership agreement. Sometimes, partners form limited partnerships or limited liability partnerships, which require an official state filing. While JVs are also usually formed by an agreement—usually called a “joint venture agreement”—they don’t necessarily result in the formation of a single business. A separate business can be created for the purpose of fulfilling the goals of the JV, but it’s not necessary—unlike a partnership.
Scope and duration. A JV is typically set up for one transaction or a series of transactions. Therefore, JVs are generally distinguished from partnerships by their limited scopes and durations. A partnership, on the other hand, ordinarily engages in an ongoing business for an indefinite period of time.
Specific purpose. In a JV, it might not be just profit that binds the parties together. JVs can be formed for specific purposes such as when parties engage in research and development—activities that would otherwise be cost-prohibitive to do individually.
Ownership and control. In a partnership, generally, the partners share equally in the ownership and control of the business. But the partnership agreement can spell out each owner’s ownership share and duties in the partnership. In a JV, each party’s share of ownership, profits, and control is usually outlined in the joint venture agreement. If a new business entity is started to run the venture, then the type of entity—such as a corporation or limited liability company (LLC)—can determine how the parties own and manage the business.
However, these distinctions between the business structures aren’t ironclad, and a court could determine a partnership was formed even for a single business transaction.
One of the main reasons business owners should be concerned about the election between a partnership and a JV is taxes.
Partnerships are considered “pass-through” tax entities where all of the profits and losses of the partnership pass through the business to the partners. The partners each pay taxes on their share of the profits (or deduct their share of the losses) on their individual income tax returns.
As a pass-through business entity owner, partners in a partnership might be able to take advantage of the 20% pass-through deduction established under the Tax Cuts and Jobs Act (TCJA). With this tax deduction, if a partner makes $100,000 in income, they might only be taxed on $80,000 (or 80% of their income). This tax break can result in significant savings, and partners can even qualify for a lower tax bracket with a lower rate.
For additional information, read how partnerships are taxed.
Depending on the circumstances, JVs can be taxed either as a
Entities that are taxed as corporations are subject to tax at both the corporate and shareholder levels, commonly referred to as double taxation. The TCJA established a single flat tax rate of 21% for corporations—a significant change that made the corporate tax rate lower than the top five individual tax rates.
There are advantages and disadvantages to each form of taxation.
One benefit of partnerships is that they offer greater flexibility with regard to the allocation of gains and losses. For example, you might be able to structure your partnership so that one partner receives 50% of the gains generated by the business and 99% of the losses—an arrangement that might benefit the individuals in your group.
However, you or others in your group might not want to report income on your personal returns, and therefore corporate tax treatment might be better.
Your decision might also depend on whether you can take the 20% tax deduction available to partners or if your overall tax rate is better with a flat 21% corporate rate.
Another issue to consider in deciding between a JV and a partnership is liability. Generally, partners in a partnership are jointly and severally liable for the partnership’s obligations. So, every partner is personally liable for:
In general, the members of a JV that’s been set up as a separate corporation or LLC will only be liable to the extent of their investment in the corporation’s stock or their interest in the LLC. But there are situations where JV members will become personally liable for the corporation or LLC’s debts and obligations.
If the JV is established by contract (as opposed to a separate legal entity), then the parties are personally exposed to liabilities related to the venture, similar to a partnership.
A partner in a general partnership owes a fiduciary duty to the partnership and to the other partners. This duty includes duties of loyalty, care, and good faith to the other partners and the partnership.
The fiduciary duties of co-venturers are similar to those owed by a partner in a partnership, although, JVs aren’t always treated the same as partnerships. For instance, the fiduciary duties of a member of a JV are often deemed finite and tailored to the business and activities of the venture, while partnership fiduciary duties are more broadly applied.
Whether you have established a partnership or JV will depend on a number of factors including:
Business owners should be careful to understand which type of arrangement they’re entering into and the consequences of that choice.
If you’re considering entering into a business relationship with another person or business entity, you’re bound to have questions or concerns. If you’ve entered into business contracts before, then you can likely navigate the situation on your own. But business arrangements can often become complicated, and it’s important to define your business relationship at the start before any issues can arise.
If you have legal questions specific to your situation or you and your partner or co-venturer have different opinions about how the business arrangement should look, you should talk to a business lawyer. An attorney can help you negotiate terms with the other party and draft an agreement to govern your business relationship.
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Before deciding on a legal structure for your business, you should determine what you need and value. While LLCs and LLPs share many characteristics, each business type is different and must comply with its own set of state laws.
An LLC is a business entity with one or more owners, who are known as “members.” You can usually create an LLC by filing formation paperwork—usually called “articles of organization”—with your secretary of state.
When properly formed, the business is a separate entity from its owners. So, you can purchase property and open a bank account under your LLC’s name. In most cases, your business will also have its own tax identification number (or “EIN”).
An LLP is essentially a general partnership—where each partner participates in the business’s operations—with the addition of limited liability for one or more partners. A general partnership is formed whenever two or more people do business together, and it doesn’t require any legal filings. However, to create an LLP, you must file formal paperwork with the state—similar to the process for starting a limited partnership.
Like an LLC, an LLP is a separate business entity with its own funds, property, and EIN. But be aware that not every state recognizes LLPs. For the states that do, their laws can vary—sometimes significantly.
LLCs and LLPs share many characteristics. They can both offer owners limited liability, tax benefits, and flexible management roles. But on closer look, these business structures differ in meaningful ways.
Both provide limited liability for owners. Both an LLC and an LLP provide their owners with some protection against personal liability, typically reducing each owner’s liability to the amount they invested in the business. For example, in this case, if an owner invested $8,000 into their company, then they’d only stand to, at most, lose their $8,000 investment.
Generally, an LLC provides the most liability protection. Except for cases of business mismanagement, the members aren’t personally responsible if the LLC is sued or owes any debt. This limited liability serves to protect personal assets like members’ houses, bank accounts, and cars.
An LLP has varying limited liability protections. The partners of an LLP might also have limited liability, but the degree of liability protection depends on the state where the LLP was filed. In some states, LLP partners aren’t responsible for another partner’s negligent acts, but they remain personally responsible for the overall debts and obligations of the business. Other states require at least one partner to have unlimited personal liability, while other partners are protected from business debts and obligations.
Your state’s laws can help determine whether an LLC or LLP works best for your company. If your state doesn’t recognize LLPs, you can either file for an LLC or look to another state that does accept LLPs. If your state does have LLP laws but the protection for owners is minimal, then it might be best to choose an LLC.
An LLC can opt to be taxed as a:
In contrast, an LLP must file as a partnership.
Sole proprietorships and partnerships are considered “pass-through entities” by the IRS. So, the business’s income is passed through to the owners, who report their share of the profits on their individual tax returns.
If the LLC is filed as a corporation, the business first pays tax on its corporate tax return. Then each owner is taxed on their share of the income on their personal tax return. (For more information, read how corporations are taxed.)
Pass-through tax deduction. Owners of both LLCs (that aren’t taxed as corporations) and LLPs can take advantage of the 20% pass-through deduction created by the Tax Cuts and Jobs Act. Under this law, you—as the owner of a pass-through entity—can deduct up to 20% of your business profits from your personal tax return. For example, if you made $100,000, you could only be taxed on $80,000 (or 80% of your income). However, there are some limitations to this complex tax break.
If you want to be taxed as a pass-through entity, you’ll see many of the same tax advantages in an LLC and LLP. But if you want to choose how your business is taxed, an LLC offers you the flexibility that an LLP doesn’t.
Another difference between the two entities is the process for determining the management structure. As mentioned earlier, an LLC can have only one member (known as a “single-member LLC”), while an LLP must have at least two partners.
Both business structures have governing documents that provide rules and procedures for running the company. Both types of agreements provide flexibility and allow owners to choose how each partner contributes and participates in the business.
An LLC is managed according to its operating agreement, which is created by the members. This document outlines:
You can opt to have a member-managed LLC where all of the owners have a say in how the business is run. Alternatively, you can create a manager-managed LLC where you have passive owners or investors who aren’t involved in the decision making for the company. (For more information about the differences in LLC management structures, read our article on member-managed vs. manager-managed LLCs.)
With an LLP, the management structure is determined by the partnership agreement. Like the operating agreement, the partnership agreement details each partner’s:
You have the option to specify one partner as a “silent partner.” Like in a management-managed LLC, the silent partner will receive a share of the partnership’s proceeds but won’t participate in decision making for the business.
Take time to weigh the pros and cons of each business structure. It’s generally challenging—as well as costly and time-consuming—to change the business structure after you’ve made the state filings. Overall, if your main concern is limiting liability or tax flexibility, an LLC is probably your best option. (For more information, read about the advantages of an LLC.)
However, take a look at your state tax laws; some states might impose a higher tax on LLCs than on LLPs.
In some cases, the decision can be made for you based on the state where you want to file and the type of business you want to have. For instance, if you’re running the business on your own without partners, you can’t form an LLP.
Additionally, not every state allows you to form an LLP. Moreover, some states only allow professional businesses, like accounting firms and law offices, to use LLPs. Similarly, some professionals might not be allowed to form an LLC, and they instead must choose an alternate structure—like an LLP—for protection.
(If you’re considering forming an LLC, read our article on the 6 questions to ask before forming an LLC.)
If you have a good understanding of LLCs and LLPs and you’re clear on what your business needs, you can probably make the choice between the two business structures on your own. But if you have questions about your state’s business laws or are unsure about which business type is the right choice for you, you should talk to a small business lawyer. They can help you review and understand your state’s laws and advise you on whether an LLC or LLP will best benefit you.
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You can form three basic types of partnerships. However, this article focuses on general partnerships, the more common structure in which every partner has a hand in managing the business. (For answers to specific questions, see our FAQ on partnerships.)
There are three common types of partnerships:
Whether you should form a general partnership depends on how you want to run your business. Running a partnership comes with both its advantages and disadvantages. You should consider these factors before deciding on your business structure.
General partnerships are usually formed by business owners who want to be personally involved in a business’s activities and don’t want to take on the added obligations of registering a business with the state.
Partnerships are easy to form and don’t require filing any documents with the state. Because your business isn’t registered with the state, you don’t need to file annual reports or pay any fees.
A partnership isn’t a separate tax entity from its owners. Instead, the IRS categorizes a partnership as a "pass-through entity." A pass-through entity means that the partnership itself doesn’t pay any income taxes on profits.
Business income simply "passes through" the business to the partners, who report their share of profits (or losses) on their individual income tax returns. Each partner must make quarterly estimated tax payments to the IRS each year.
Pass-through tax deduction. As owners of a pass-through business entity, partners might be able to take advantage of a 20% pass-through deduction. With this deduction—established under the Tax Cuts and Jobs Act—you could be taxed on only 80% of your income.
Paying partnership taxes. While the partnership itself doesn't pay taxes, it must file IRS Form 1065, an informational return, each year. This form sets out each partner's share of the partnership’s profits or losses, which the IRS reviews to make sure the partners are reporting their income correctly. (For more information on reporting and paying partnership taxes, read our article on how partnerships are taxed.)
While a partnership might be simple, it does come with its disadvantages.
General partners are personally liable for all business debts and obligations, including court judgments. So, if the business itself can't pay a creditor (such as a supplier, lender, or landlord), the creditor can legally come after any partner's personal assets, such as their house, car, or other possessions.
For example, suppose Johnny and Mark run a flower shop as partners in a general partnership. Business slows and the partnership falls behind on rent. The landlord, Lisa, demands the partnership pay $3,000, the money owed in rent. Lisa learns that the partnership doesn’t have any money to pay her back so she sues Johnny and Mark personally for the rent owed. Because Johnny and Mark are personally liable for the partnership’s debts, they’ll have to pay Lisa the $3,000 out of their own pockets.
Each individual partner can be sued for—and required to pay—the full amount of any business debt. For instance, suppose Wanda and Pietro start a moving company. During one move, an employee of the partnership accidentally ruins a customer’s bedroom set worth $12,000. The owner of the bedroom set, Ulysses, sues Wanda individually for the damaged furniture. Because Wanda is a general partner, the court could order Wanda to pay Ulysses the full $12,000 for the damaged furniture.
If one partner is sued and forced to pay the entirety of a business debt, that partner might be able to sue the other partners for their shares of the debt. Your partnership agreement can determine how the partners share in the business’s debts and liabilities. For instance, your partnership agreement might say that the partners must share equally in the business’s debts.
Using our previous example, suppose Wanda and Pietro have a partnership agreement that says that each of them is responsible for 50% of the partnership’s debts and liabilities. If the court ordered Wanda to pay Ulysses $12,000, Wanda could then sue Pietro for $6,000, or half of the $12,000 court judgment.
If you don’t have a partnership agreement or your agreement is silent on debt allocation, then you should follow your state’s partnership laws.
Any individual partner can usually bind the whole business to a contract or other business deal. For instance, if your partner signs a year-long contract with a supplier to buy inventory at a price your business can't afford, your partnership is bound to that contract and price point. So, you can be held personally responsible for the money owed under the contract even though your partner—and not you—signed the contract on behalf of the partnership.
There are just a few limits on a partner's ability to commit the partnership to a deal. For instance, one partner can't usually bind the partnership to a sale of all of the partnership's assets. But generally—unless the other party of the contract has reason to know that the signing partner doesn’t have the authority to bind the partnership—any partner can bind the other partners to a deal.
Because of the combination of personal liability for all partnership debt and the authority of each partner to bind the partnership, it's critical that you trust the people with whom you start your business.
You don't have to file any paperwork to establish an ordinary partnership—just agreeing to go into business with another person is enough.
But you’ll need to meet the same requirements as any new business as they apply to you. You might be required to take the following steps:
Draft a partnership agreement. While the owners of a partnership aren’t legally required to have a written partnership agreement, it makes good sense to put the details of ownership, including the partners' rights and responsibilities and their share of profits, into a written agreement.
Draft a buyout agreement. You’ll want to have a plan for what will happen when one partner retires, dies, becomes disabled, or leaves the partnership to pursue other interests. While some partnerships end when a partner withdraws, others continue. A partnership buyout agreement—also called a “buy-sell agreement”—can detail when and how you can buy a partner’s share of the business.
For more information on the steps you should take, read our article on how to form a partnership.
A partnership can end (or “dissolve”) for various reasons, such as:
When the partners decide to end a partnership, you’ll need to take care of a few matters before your business can officially close, including paying off debts and dividing any remaining assets among the partners. For more information on the steps to take to end a partnership, see our article on dissolving a partnership.
Many business owners form, run, and end their partnerships themselves by relying on their own experience or self-help resources. But some owners find it helpful to reach out to a small business attorney to help them create or dissolve their partnership, particularly when there’s a dispute over business assets or a list of debts. A lawyer can help you draft a partnership agreement, including the buyout provisions. They can also help you negotiate with creditors and assess your personal liability for the partnership’s debts.
If you’re looking to educate yourself further about partnership formation, check out Form a Partnership: The Complete Legal Guide, by Ralph Warner and Denis Clifford (Nolo). If you want to learn more about buyout agreements, including what a sample buyout agreement looks like, see Business Buyout Agreements: A Step-by-Step Guide for Co-Owners, by Bethany Laurence and Anthony Mancuso (Nolo).
]]>Generally, the IRS does not consider partnerships to be separate from their owners for tax purposes; instead, they are considered "pass-through" tax entities. This means that all of the profits and losses of the partnership "pass through" the business to the partners, who pay taxes on their share of the profits (or deduct their share of the losses) on their individual income tax returns. Each partner's share of profits and losses is usually set out in a written partnership agreement. As a pass-through business entity owner, partners in a partnership may be able to deduct 20% of their business income with the 20% pass-through deduction established under the Tax Cuts and Jobs Act. See The 20% Pass-Through Tax Deduction for Business Owners for more information.
Even though the partnership itself does not pay income taxes, it must file Form 1065 with the IRS. This form is an informational return the IRS reviews to determine whether the partners are reporting their income correctly. The partnership must also provide a Schedule K-1 to the IRS and to each partner, which breaks down each partner's share of the business's profits and losses. In turn, each partner reports this profit and loss information on his or her individual tax return (Form 1040), with Schedule E attached.
Because there is no employer to compute and withhold income taxes, each partner must set aside enough money to pay taxes on his share of annual profits. Partners must estimate the amount of tax they will owe for the year and make payments to the IRS (and usually to the appropriate state tax agency) each quarter -- in April, July, October, and January.
The IRS requires each partner to pay income taxes on his "distributive share." This is the portion of profits to which the partner is entitled under a partnership agreement -- or under state law, if the partners didn't make an agreement. The IRS treats each partner as though he or she received his distributive share each year. This means that you must pay taxes on your share of the partnership's profits -- total sales minus expenses -- regardless of how much money you actually withdraw from the business.
The practical significance of the IRS rule about distributive shares is that even if partners need to leave profits in the partnership -- for instance, to cover future expenses or expand the business -- each partner will owe income tax on his or her rightful share of that money. (If your business will regularly need to retain profits, you should consider incorporating -- corporations offer some relief from this particular tax bite.)
Unless business partners make a written partnership agreement that says otherwise, state law usually allocates profits and losses to the partners according to their ownership interests in the business. This allocation determines each partner's distributive share. For instance, if Andre owns 60% of a partnership and Jenya owns the other 40%, Andre will be entitled to 60% of the partnership's profits and losses and Jenya will be entitled to 40%. (In addition, state law assumes that each partner's interest in the business is in proportion to the value of his or her initial contribution to the partnership.)
If you'd like to split up profits and losses in a way that is not proportionate to the partners' percentage interests in the business, it's called a "special allocation," and you must carefully follow IRS rules.
If you are actively involved in running a partnership, in addition to income taxes, the IRS requires you to pay "self-employment" taxes on all partnership profits allocated to you. Self-employment taxes consist of contributions to the Social Security and Medicare programs, similar to the payroll taxes employees must pay.
There are some differences between the contributions regular employees make and the contributions partners must make. First, because no employer withholds these taxes from partners' paychecks, partners must pay them with their regular income taxes. Also, partners must pay twice as much as regular employees, because employees' contributions are matched by their employers. However, partners can deduct half of their self-employment tax contribution from their taxable income, which lowers their tax bill a bit.
Partners report their self-employment taxes on Schedule SE, which they submit annually with their personal income tax returns.
You may be wondering how you will survive financially, after paying income taxes, Social Security taxes, and Medicare taxes on your share of business income, even if you don't withdraw it from your business. Luckily, you don't have to pay taxes on most of the money your business spends to make a buck.
You and your partners can deduct your legitimate business expenses from your business income, which will greatly lower the profits you have to report to the IRS. Deductible expenses include start-up costs, operating expenses, travel costs, and product and advertising outlays, as well as a portion of the money you spend on business-related meals and entertainment. For information about allowable expenses and deductions, see Nolo's articles Small Business Tax Deductions and Top Tax Deductions For Your Small Business.
If you're confused by partnership taxes, you're not alone. A good way to learn the basics is to read Tax Savvy for Small Business, by Fred Daily (Nolo). Then, plan to get the help you need from a tax adviser who specializes in partnership taxation, to make sure you comply with the complex tax rules that apply to your business and stay on the good side of the IRS.
Unlike a partnership, a corporation pays its own taxes on all corporate profits left in the business. Owners of corporations pay income taxes only on money they receive as compensation for services (salaries and bonuses) or as dividends.
While many small businesses would rather not file a corporate tax return, incorporating can offer business owners a tax advantage over a partnership's "pass through" taxation. This is especially true for businesses that expect to retain profits in the business from year to year.
If you need to keep profits (called "retained earnings") in your business, you may benefit from lower corporate tax rates, at least for the first $50,000 - $75,000 of profits per year. For example, if your retail outfit needs to stock up on expensive inventory, you might decide to leave $30,000 in your business at the end of a year. If you operate as a partnership, these retained profits will likely be taxed at your marginal individual tax rate, which is probably more than 25%. But if you incorporate, that $30,000 will be taxed at a lower 15% corporate rate. To get a better idea of whether you should incorporate to reduce taxes, see Nolo's article How Corporations Are Taxed.
For a thorough explanation of the legal and practical issues involved in forming a business partnership, see Form a Partnership: The Complete Legal Guide, by Ralph Warner & Denis Clifford (Nolo).
]]>A partnership agreement allows you to structure your relationship with your partners in a way that suits your business. You and your partners can establish the shares of profits (or losses) each partner will take, the responsibilities of each partner, what will happen to the business if a partner leaves, and other important guidelines.
Each state (with the exception of Louisiana) has its own laws governing partnerships, contained in what's usually called "The Uniform Partnership Act" or "The Revised Uniform Partnership Act" (or the "UPA" or "Revised UPA"). These statutes establish the basic legal rules that apply to partnerships and will control many aspects of your partnership's life unless you set out different rules in a written partnership agreement. (To find your state's partnership statutes, see Nolo's State Law Resources Legal Research page.)
Don't be tempted to leave the terms of your partnership up to these state laws. Because they were designed as one-size-fits-all fallback rules, they may not be helpful in your particular situation. It's much better to have an agreement in which you and your partners state the rules that will apply to your business.
Here's a list of the major areas that most partnership agreements cover. You and your partners-to-be should consider these issues before you put the terms in writing:
As you can see, there are many issues to consider before you and your partners open for business -- and you shouldn't wait for a conflict to arise before hammering out some sound rules and procedures. A good self-help book, such as Form a Partnership: The Complete Legal Guide, by Denis Clifford and Ralph Warner (Nolo), can help you think through the details and put them in writing.
]]>Here are some key issues to consider in determining fiduciary duties owed to a partnership.
In operating either a general or limited partnership, partners must be able to trust and rely upon those partners managing the partnership to promote the best interests and success of the partnership. Thus, having a management role is key to the finding of owing a fiduciary duty in a partnership. Typically, the general partners in a general partnership or limited partnership participate in the daily operation and supervision of the business. Because of their role in managing the partnership, general partners are usually viewed as having fiduciary duties in both a general partnership and limited partnership.
In limited partnerships, limited partners usually provide capital resources and are not involved in managing the business, leaving operational duties to the general partners instead. Non-managing limited partners typically do not owe fiduciary duties to the limited partnership. However, limited partners who participate in directing or operating a limited partnership could end up treated as general partners by a court with the associated fiduciary duties.
Under this duty, partners must act with honesty and show good faith and fairness to each other in their partnership interactions. This continuing duty arises starting with the formation of the partnership. It continues through the partnership's ongoing daily operations and ultimately through the partnership's sale or dissolution. This obligation underlies the performance of all the other fiduciary duties in a partnership.
The duty of loyalty requires relevant partners to place the success and interests of their partnership above their own personal or other business interests. Impacted partners should avoid any conflicts of interest between their partnership duties and their other personal and business activities. As part of the duty of loyalty, one must properly hold partnership property in trust for the benefit of the partners and not use it for one’s own personal advantage. For example, a general partnership may own an office building, but a general partner should not dispose of that partnership asset for his or her individual economic gain to the detriment of the partnership. In some instances, you may be allowed to obtain an individual benefit from partnership assets after full disclosure to and prior approval from the other partners.
Under the duty of care, partners are expected to act in a reasonably prudent manner in managing and directing the partnership. For example, a general partnership is expected to keep complete and accurate business records for the business. Therefore, a reasonably prudent businessperson would implement appropriate audit controls and procedures to ensure proper accounting and preservation of partnership funds and assets. Under the business judgment rule, a partner is normally not held liable for business decisions made in good faith and with reasonable care that turn out to be erroneous.
Partners involved in managing partnership affairs are expected to comply with a duty of disclosure or candor. In order to make informed decisions, participating partners should make full disclosures about reasonably known risks and potential benefits of a particular action. These disclosures relate to all partnership activities, including partnership assets, operations, finances, debt, and contracts. Candor is particularly important in instances involving the sale of the business or potential conflicts of interests in business dealings. As part of their duty of disclosure, relevant partners should disclose any conflict of interest they may have relative to any partnership dealings or decisions.
Fiduciary duties are spelled out in your state’s statutory law or through judicial determinations. Depending upon your state, partners may limit, expand, or eliminate fiduciary duties by agreement, provided that these changes are reasonable under the circumstances. Under state law, certain fiduciary duties can not be eliminated by agreement. It may be helpful to contact an attorney to determine your relevant fiduciary duties in your state and to see if you may alter or do away with certain fiduciary obligations in your partnership agreement.
]]>As with most important matters affecting your partnership, the first step in dissolving your partnership is to check your partnership agreement. While a written partnership agreement is not required in California, ideally, you and your partners would have prepared a partnership agreement when you first formed your partnership or at some later point in time. If you don’t have a preexisting partnership agreement, you’ll have to fall back on the default provisions of the state’s Uniform Partnership Act.
Along with reviewing the partnership agreement, it’s a good idea for all of the partners to discuss the dissolution. Two of the key points to address are:
If you have a well-written partnership agreement, it should provide guidance on these points. You may even be able to simply follow what’s laid out in the agreement. On the other hand, there may be cases where you’ll want individual partners to pay particular debts, and those responsibilities will not be covered by the partnership agreement. If so, you’ll now want to come to an agreement about who will pay what, and put that agreement in writing.
Assuming you have a partnership agreement and it contains provisions on how to dissolve, you should follow those provisions. In most cases, dissolution provisions in a partnership agreement will state that all or a majority of partners must consent before the partnership can dissolve. In such cases, you should have all partners vote on a resolution to dissolve the partnership. Ideally, there will be the unanimous or majority consent required by the agreement. You should record in writing the results of the vote to dissolve.
If you want to dissolve your partnership because of a disagreement among the partners, and not all the partners are in agreement regarding dissolution, you usually have a couple options. First, the partnership agreement may provide a solution. For example, there often is an option for partners who want to continue the business to buy out one or more partners who want to leave. Or you could bring in an independent mediator to try to help resolve the disagreements. Ultimately, however, if the partners can’t come to an agreement after trying other options, you’ll have to fall back on going to court and getting a judge to decide how the dissolution will proceed. You should try to avoid going to court, but if you really have no choice, you and your fellow partners should be represented by lawyers.
If you don’t have a partnership agreement, you’ll have to rely on the Uniform Partnership Act. California’s version of this Act is different than in other states. In general terms, it provides that an at-will partnership will be dissolved by the express will to dissolve of at least half the partners, including partners who dissociated from (left) the partnership within the preceding 90 days. You can accomplish this by having a majority of the current and recently-dissociated partners vote in favor of a written resolution to dissolve. It is also possible for remaining partners to choose to continue the partnership without the dissociated partners.
After you have voted to dissolve under the rules of the partnership agreement—or, in the absence of an agreement, the partnership has dissolved under the rules of the Partnership Act—you need to take some additional steps to close down the business. These steps are often referred to as winding up the partnership. In general, the steps include:
It’s particularly important that all debts are paid before you make any distributions to the partners. California’s Uniform Partnership Act has rules for the order in which people get paid when winding up a partnership. In general, creditors must be paid first, then partners are entitled to receive back their capital contributions, and, finally, if anything remains, the partners are entitled to distributions.
In California, general partnerships are not required to file a form when they dissolve. However, many California general partnerships file Form GP-1, Statement of Partnership Authority, with the Secretary of State (SOS) when first formed. In those cases, the partnership should file Form GP-4, Statement of Dissolution, when the partnership dissolves. Filing a Statement of Dissolution will help make clear that your partnership has ended and limit your liability. You cannot file a Statement of Dissolution unless you have first filed a Statement of Partnership Authority.
You can file the Statement of Dissolution online or on paper. For either method, go the Forms Section of the SOS website. There is no filing fee. Under California law, other people generally are considered to have notice of the partnership’s dissolution ninety (90) days after filing the Statement of Dissolution.
While not a legal requirement, you should make sure to notify creditors, customers, and others that your partnership is dissolving. In some cases, if one of your partners makes a deal with someone after dissolution, you and your fellow partners could be on the hook for that deal—including any debts involved—if the other party didn’t have notice of the dissolution.
There are several options for how to give people notice of the dissolution. One option is to send them written notification. Another good option is to publish a notice in one or more local newspapers.
California does not require that you obtain tax clearance before dissolving your partnership. However, the CaliforniaFranchise Tax Board (FTB) does require you to file a final tax return for your partnership and pay any state taxes due with that return. For federal tax purposes, check the “final return” box on your IRS Form 1065. Under IRS rules, if your partnership terminates before the end of its normal tax year, the final federal return is due by 15th day of the fourth month following the termination date.
In addition, if you partnership had a seller’s permit (for collecting sales tax), you must inform the California StateBoard of Equalization (BOE) in writing that you are closing your business. You can use Form BOE-65, Notice of Close-Out, to satisfy this requirement. (The BOE also should be notified any time a partner is added or dropped.)
Is your partnership registered or qualified to do business in other states? If so, you must file separate forms to terminate your right to conduct business in those states. Depending on the states involved, the form might be called a termination of registration, certificate of termination of existence, application of withdrawal, or certificate of surrender of right to transact business. Failure to file the additional termination forms means you’ll continue to be liable for annual report fees and minimum business taxes.
You can find additional information, such as forms, mailing addresses, and filing fees, on the SOS website. For information on dissolving and winding up partnerships formed in other states, check Nolo’s 50-state series on dissolving partnerships.
Dissolving and winding up your partnership is only one piece of the process of closing your business. For further, general guidance on many of the other steps involved, check Nolo’s 20-point checklist for closing a business and the Nolo article on what you need to know about closing a business.
]]>General partnerships involve two or more parties who voluntarily agree to own and run a for-profit business in which they equally share management duties and profits or losses. Limited partnerships are made up of at least one general partner who finances and manages a for-profit business as well as one or more limited partners who provide only capital to that partnership entity. LLCs combine positive features of both partnerships and corporations.
Many state laws have adopted all or part of uniform laws that help govern general partnerships, limited partnerships, and LLCs. This overall review of general and limited partnerships and LLCs focuses on four key aspects: formation, management, profit-sharing, and legal liability. For information on taxes, see How Partnerships Are Taxed and How LLC Members Are Taxed.
A general partnership can be formed in a variety of formal and informal ways, including orally, in writing or implied by a court from party conduct, such as pooling capital resources and sharing management duties and business profits or losses. Although not required to do so, it is always recommended that you form a general partnership in a written partnership agreement or articles of partnership. This type of agreement spells out each partner’s rights and duties and helps avoid future litigation between partners. Some states require the filing of a certificate of partnership to evidence the existence of a general partnership.
Under most state laws, limited partnerships are established in a more formal way through a required filing of a certificate of partnership with the relevant department, normally the secretary of state’s office. Similar to general partnerships, the general and limited partners may wish to enter into articles of limited partnership to clarify partner roles and obligations in operating the business.
Although less complex to form than a standard corporation, LLCs require more formal documentation than general partnerships. For multi-member LLCs, the owners must enter into an operating agreement to clarify members’ different rights and responsibilities. LLCs must register articles of organization with a relevant state office. These articles of organization usually identify an LLC’s name, the location of its principal offices, the identities of its owners, any planned LLC term or duration, along with other statutory requirements.
A key characteristic of a general partnership is the equal right of each partner to manage the business enterprise. Typically each general partner possesses one vote in any key partnership decisions regardless of the amount of their individual capital contribution. Simple majorities normally determine the outcome of key business determinations. Under this business organization, general partners must be able to persuade their co-owners to agree with certain business policies or ideas.
Limited partnerships may have either one general partner or two or more general partners who operate a limited partnership on a daily basis. In a limited partnership with two or more general partners, the management framework amongst the general partners is often similar to general partnerships. Limited partners do not manage the business and supply only capital contributions.
If you are a single-member LLC, you own, manage, and operate your business. As a single-owner LLC, you can set your own business strategies and policies without having to consult or seek approval from others. If there are two or more members, your LLC’s operating agreement may be used to structure management roles and decision-making authority in a way that best suits your business needs. You may decide that all members will manage the LLC or you can delegate management and decision-making powers to certain designated members.
The division of profits and losses are similar for both general partnerships and multi-member LLCs. Unless the partners agree otherwise, general partners and LLC members share equally in the profits of their respective business organizations.
Under a limited partnership, general and limited partners usually share profits and losses based upon the value or percentage of each partner’s capital contributions to the business. Alternatively, general and limited partners as well as LLC owners possess the flexibility to enter into agreements to allocate business profits and losses in a different manner that best suits their respective business models.
Like many aspects of the law, legal liability often follows party control or authority. In both general and limited partnerships, general partners have unlimited personal liability since they manage their respective businesses. When handling partnership business, general partners are liable for their own conduct as well as the acts of their fellow general partners, known as joint and several liability.
Conversely, limited partners only risk their capital contributions in limited partnerships, similar to shareholders in a corporation or members in an LLC. However, if a limited partner participates in managing the business or signs a personal guarantee for the business they may be held personally liable for these business obligations.
LLC members are entitled to manage the business while retaining the limited personal liability of shareholders in a corporation. Normally LLC members are not personally liable for LLC debts or legal liabilities, putting only their financial contributions to the LLC at risk. LLC owners may still be personally liable for their own conduct that harms others, for breaches of their duties owed to the LLC or any personally-guaranteed LLC loans.
Any business owner should consider appropriate insurance and other liability protection strategies to help shield personal assets and business resources.
]]>While dissolving your LP might seem like a daunting task, it’s a necessary one. Legally ending your partnership will also legally end your obligations and liabilities to it.
State law and your partnership agreement will determine the process for dissolving your LP. The procedure to dissolve your LP is very similar to the steps to dissolve a partnership. For more detailed steps, read how to dissolve your partnership to end your liability.
Though your state’s LP laws or your partnership agreement might require a slightly different procedure, you can generally follow the eight steps below to dissolve your LP.
Before you start any formal dissolution process, you need to determine whether your LP should or must dissolve. If your LP agreement—also called a “partnership agreement”—spells out the bases and procedures for initiating the dissolution process, you should follow these rules.
If you don’t have an agreement or your agreement doesn’t have dissolution provisions, then you should follow your state’s laws. If you want to handle the dissolution differently from the default rules provided by your state's LP laws (and you don't have a partnership agreement) then you and your partners should draft a partnership dissolution agreement.
Sometimes, a specific event relating to a partner will require a general partnership to end. With LPs, usually, only events related to general partners—not limited partners—will require the LP to end. For instance, a partnership agreement might require the LP to end if a general partner dies, but not if a limited partner dies.
Typical events that might end an LP include:
Your partnership agreement or dissolution agreement should also spell out:
Unless an event triggers your LP’s dissolution, you’ll likely need the partners to agree to dissolve the business. Your partnership agreement should specify:
Your agreement should also provide instructions for how the vote should be carried out—for example, whether the vote needs to be in person. Regardless of whether a specific event triggers the dissolution or the partners vote to dissolve, you should record the partners’ decision and keep it with company records.
You can usually file the dissolution papers online with your state’s secretary of state’s office or corporations division. The form for dissolving an LP is sometimes called a “certificate of cancellation” or “statement of dissolution.” Some states require you to file two forms. Check your secretary of state’s website for instructions on which forms to file.
You might need to receive tax clearance before you can dissolve your LP. Some states require you to receive tax clearance from your state’s tax authority. To receive tax clearance, you’ll need to pay any outstanding state taxes for your LP. Once you pay your business taxes, you can obtain a tax clearance letter or form—sometimes called a “certificate of account status” or “tax clearance certificate”—from your state agency that handles taxes (usually the department of revenue).
You might be required to wind up your business before you can dissolve your LP. You should check your state’s LP dissolution requirements for guidance. If you need to wind up your LP first, you’ll submit your dissolution forms at the end of the winding-up process.
Once your LP is dissolved, you can prevent your partners from binding the LP to new obligations and liabilities after dissolution. For example, suppose you file to dissolve your LP on April 1st. On April 10th, your former partner signs a contract under your LP’s name with another company, Topanga Technologies. You probably won’t have to honor the contract your former partner signed because Topanga Technologies had notice of your partnership’s dissolution when you filed your dissolution statement with your state.
If you’re a general partner and personally liable for the business’s debts, officially cutting ties with your LP and partners is critical. You don’t want to be forced to pay a debt that your former partner signed up for when you were no longer in business with them.
As with dissolving a general partnership, you should publish a formal notice of your LP’s dissolution in a local newspaper. By properly notifying the public of the dissolution, any creditors or other third parties are given a limited time period to step forward with any valid claims against the partnership. This notice and publication process can help avoid unexpected future lawsuits and other liability risks at a later date.
While your LP was operating, your business might’ve entered into agreements with a wide range of third parties, including:
You should notify applicable third parties about the partnership’s dissolution if you haven’t already. Look over these contracts for any notice and termination requirements as well as any remaining obligations you might owe. For instance, you might be required to give 30 days written notice to terminate a contract.
Reviewing these contracts might help guide the general partners in closing down the business. They can set aside adequate resources to comply with outstanding debt or contractual obligations.
For example, suppose your LP is contracted to order 100 yards of fabric every two weeks. Your contract’s termination provision requires you to give seven days' notice to cancel the contract. You’re LP dissolves but you’re contracted to purchase 100 more yards of fabric in two days—five days short of your minimum notice requirement. Unless you can get your supplier to waive the notice requirement, you’ll need to make one more fabric purchase and cancel the contract. So, you’ll need to make sure you set aside funds to make the final purchase as you’re winding up your LP.
Once you’ve notified your creditors of your LP’s dissolution and reviewed your contracts, you should settle your business debts. If you have any assets you can liquidate—such as equipment or inventory—sell them. You can use that money to pay your creditors and distribute the rest of the funds to the partners.
If you have any money left over after settling your partnership’s debts, you can distribute the remaining funds to the partners. You should distribute the business’s assets based on each partner’s capital account. This account represents how much the LP owes a partner based on their distribution share.
If you opened a business bank account for your LP, close it.
Take account of any registrations, licenses, and permits your LP holds. For instance, if your company sells goods, you might have a seller’s permit. You might be able to transfer some business licenses or permits when you sell your assets. Cancel any remaining business licenses or permits. If you don’t, you could face liabilities such as renewal fees and fines.
If you or your partners have experience liquidating and closing a business, you can probably dissolve your LP on your own. But if you have a long list of business debts and obligations, it could be a good idea to talk to a business lawyer. They can help you review your business contracts, negotiate with creditors, and file the necessary documents to end your LP’s legal existence.
]]>Contrary to popular belief, a buy-sell agreement isn’t about buying and selling companies. A buy-sell agreement is a binding contract between business partners about the future ownership of the company. Because of this confusing terminology, we’ll use the term buyout agreement from now on.
A buyout agreement can stand on its own or it can be several provisions in your written partnership agreement. The agreement controls the following business decisions:
You can think of a buyout agreement as a sort of "prenuptial agreement" between you and your partners: Although you might think that your partnership will last as long as you all shall live, the buyout determines what’ll happen if things don't go exactly as you planned. (For more information, see our FAQ on partnership buyout agreements.)
Your buyout agreement will instruct you and your partners on how to handle the sale or buyback of an ownership interest when one partner's circumstances change. Without one, if one partner quits to move to another city or leaves to start another business, your partnership might, by law, be dissolved. A dissolution of your partnership could force you to divide any assets and profits among the partners and to decide whether to start a new company with the remaining partners.
Even if your partnership doesn't end, you might still have an argument over whether you should buy out the departing partner's ownership interest, and for how much. If you don't anticipate and plan for circumstances like these, you risk serious personal and business disputes—perhaps even court battles and the loss of your business.
In addition, a buyout agreement can control who can buy into the partnership. Otherwise, you might be stuck sharing control of the company with someone you’d rather not run a business with.
Your agreement should address when a partner can or must be bought out of their partnership interest and the procedure to buy out the partner. If you decide on these issues before your partnership faces a buyout, you can feel more comfortable that the process will be reasonably fair and relatively free of any additional hostility or resentment. (For more information on how to manage your partnership, read our article on partnership FAQ.)
Typically, the events that trigger a buyout of a partner's interest under a buyout agreement are:
Once a buyout is triggered, you need to know who can buy the departing partner’s partnership share. There are typically three potential buyers for a partner’s share:
Your buyout terms can be vague so that anyone can buy the partnership share. Alternatively, your agreement can be restrictive so that only the partnership or other partners can buy the share. A more common option for partnerships is a mix of the two.
Many partnerships allow for anyone to buy the exiting partner’s interest but give the partnership or partners the right of first refusal to the partner’s interest. The right of first refusal means that the departing partner has to offer their share to the partnership or partners first. If they decline to purchase the share, then the partner can sell their interest to someone outside of the partnership.
For example, suppose Alvin, Simon, and Theodore have a partnership together. Alvin decides to pursue other interests and leaves the partnership. The three partners have an agreement that the other partners have the right of first refusal to a partner’s share if a partner decides to leave. So, Alvin offers his share to Simon and Theodore first as required by their buyout agreement. But both refuse to buy Alvin’s share. Alvin then sells his share to Brittany, and she becomes the new partner.
The right of first refusal protects everyone’s interests. If the remaining partners don’t want an outsider buying into the partnership, then they have a way to prevent that scenario by buying the partner’s share themselves. But the departing partner also isn’t trapped trying to sell their share to partners that don’t want to or can’t buy them out.
Once you’ve determined who can buy the share, you need to settle on a price. You don’t have to determine a fixed number right now. It can be hard to throw out a fair number when your partnership is growing and you’re not sure what the business’s true value will be when a partner leaves.
For example, suppose Donna and Jackie start a partnership where they share equally in the company. At the start of the business, each share is valued at $10,000. But they’re already predicting significant growth and they expect that in the next five years, each share will be valued at $50,000. So, in their buyout agreement, Donna and Jackie specify that if one of them leaves, they must sell their share of the partnership to the other for $50,000. Their partnership is extremely successful, and after five years Jackie wants to leave the company to pursue other interests. At the time of Jackie’s departure, her share is valued at $80,000. It would be unfair then to make Jackie sell her share back to Donna for $50,000—significantly less than what it’s worth.
To avoid landing on an unfair fixed price, many partners decide to opt for a buyout provision that values the partner’s share at the time the partner leaves based on a certain calculation method. By using this approach, the departing partner can feel secure knowing that they’ll be fairly compensated for their interest.
Usually, the price for a partner’s share is determined either by:
If a partner has died, then their estate or heir will take over the deceased partner’s responsibilities. So, if you plan to buy out the deceased partner’s share, their estate or heir will need to be compensated based on the terms of the buyout agreement.
Whatever you and your partners decide, it’s critical that everyone is satisfied with the choice. The value of a partner’s share can be the most contentious part of the buyout process if there’s any disagreement over it.
If you have experience drafting business contracts or forming partnerships, you can probably create a buyout agreement yourself. But if you and your partners can’t agree on terms or you’re not sure which terms best fit your business’s needs, you should talk to a lawyer who has experience working with partnerships. They can help you negotiate with your partners and draft an agreement for you.
If you want to create an agreement yourself but need some direction, check out Business Buyout Agreements: A Step-by-Step Guide for Co-Owners, by Anthony Mancuso and Bethany K. Laurence (Nolo). This book has a fill-in-the-blank buyout agreement and instructions on how to incorporate it into your partnership agreement.
]]>This article discusses the steps you need to take to formally dissolve and wind up your partnership.
It also covers the topic of when you might want to consult a business attorney. If you have more questions, check out our FAQ on partnerships.
While partnerships are one of the more informal business structures, you still need to take legal action to dissolve and wind up your company. Your partnership agreement and state law might have slightly different rules, but generally, you can follow these steps to end your business.
If you want to dissolve your partnership, you should approach your business partners. Your partners might agree that the business should come to an end. In that case, you should see whether your partnership agreement provides rules for dissolution, including how to vote for dissolution and how debts will be handled.
If you don’t have an agreement, then you should follow your state’s laws. If you want to handle the dissolution differently from the default rules provided by state law, and you don’t have a partnership agreement, then you and your partners should draft a partnership dissolution agreement. That agreement should lay out:
If only you want to end the partnership and your partners would like for the business to continue, the partnership can carry on as long as your partnership agreement or state law allows it to. You might be able to sell your share of the partnership to your partners or to a third party. You can look to your partnership buyout agreement or the buyout provisions in your partnership agreement—if you have them—for rules on:
If the partnership doesn’t have any written agreement, consider talking to an attorney with experience working on partnership dissolutions. They can help you draft a dissolution agreement.
If you might want to sell your share of the partnership rather than end the business altogether, it’s also a good idea to talk to a lawyer. They can help you consider your options and arrange for a clean transfer of your partnership interest.
Once you’ve talked to them about ending the business, you and your business partners need to vote to dissolve the partnership. Usually, you’ll vote to end the partnership either at a meeting or by written consent of the partners. You should record the decision in writing and keep it with your business documents.
Look to your partnership agreement for specific rules on the dissolution process. Your partnership agreement might say that only one partner needs to vote to dissolve your partnership for it to officially end. If you have more than two partners, then a majority might be required. If you have neither a partnership agreement addressing dissolution nor a separate dissolution agreement, you’ll need to follow your state’s laws on partnerships.
Sometimes a vote isn’t required—instead, certain events trigger the partnership’s dissolution. Your partnership agreement or state law might allow (or require) your partnership to end when one of the following occurs:
It's a good idea to file your state's dissolution-of-partnership form as additional proof that the partnership has been terminated. The form is usually available from your state's secretary of state or corporations division website. Some states require a small fee to file the form.
Typically, filing a partnership dissolution form with the state isn't legally required unless you filed paperwork with the state when you formed your partnership. If you have a limited partnership (LP) or limited liability partnership (LLP), then you likely registered your business with the state. In that case, you’ll need to submit a form to the state to dissolve your LP or LLP.
But if you have a general partnership—typically referred to as just a “partnership”—then you probably didn’t file any formal paperwork. However, if you did file any documents with the state throughout the life of your partnership—such as a form certifying the partners’ authority to enter into business agreements on behalf of the partnership—then your state might require you to file a dissolution statement or certificate.
For instance, in California, a partnership needs to file a certificate of dissolution form only if it filed a statement of authority with the secretary of state when the partners formed the partnership. (Cal. Corp. Code § 16805 (2023).)
Whether you’re required to file or not, to make it clear that you’re no longer in a partnership or liable for its debts, it makes sense to file the partnership dissolution form.
It also makes sense to publish a notice in the local newspaper that your partnership is no longer in business. While not usually required, publishing this notice lets everyone (including unknown creditors) know that the partnership, as well as any partner acting on its behalf, can no longer incur debts.
Providing public notice is especially important for partnerships because, as a general principle, any partner can bind the partnership to a deal without letting the other partners know. You could be on the hook for debts you don't know about.
For instance, suppose you and your partner decide to end your business relationship and you publish notice of the dissolution in your local paper. After the newspaper runs your notice, your partner signs a loan in the partnership’s name. You probably wouldn’t be liable for the business loan your former partner signed because the lender had notice that your partnership was no longer doing business.
When you’re closing down your business, you’ll probably have final debts to pay. To get a good idea of the money your partnership has available to pay off its debts, you should sell off (or “liquidate”) any physical assets in your partnership’s name.
Your physical assets could include:
Once you’ve liquidated your assets, it’s time to settle your debts. You’ll need to identify which debts your partnership is responsible for.
Look at your partnership agreement for your share of the partnership’s debts. While each partner is personally liable for all business debts—meaning a creditor can make a single partner pay the whole partnership debt—your partnership agreement should specify each partner’s obligation for company debts.
For example, suppose a creditor obtains a judgment against you personally for a $5,000 loan your partnership signed for. Your partnership agreement says that you and your partner are each responsible for 50% of the business’s debts. So, you’d be able to recover $2,500, or 50% of the $5,000 judgment, from your partner.
If you don’t have a partnership agreement, then state laws will determine your share of the debt. Usually, state laws require you and your partners to either:
Many states allow you, with few exceptions, to dispose of (or “discharge”) any business debts by providing notice to your creditors. You should send your known creditors a letter notifying them of your partnership’s dissolution. For unknown creditors, a publication in the newspaper is usually enough.
Usually, you’ll give your creditors a deadline to send you their claim for what your partnership owes them. Check your state’s laws for specific deadlines.
If you send the notice and don’t receive a claim by the deadline, then you’re usually no longer liable for the debt—that is, you don’t have to pay it, with a few exceptions. If you do receive notice of a claim, then you’ll likely need to settle the debt.
You should try to see if your creditors will settle for less than what you owe them, especially if your business is strapped for cash. If you need help negotiating with your creditors, consider reaching out to a business attorney. (For detailed guidance, read our article on negotiating debt settlements when you go out of business.)
Your business’s debts include any outstanding tax obligations. You should file your partnership’s final state tax return and pay any taxes your partnership might owe, including sales tax, to the state and local taxing authority.
You should also submit Form 1065, U.S. Return of Partnership Income to the IRS. Make sure you check the “final return” box on your state and federal tax returns. Because partnerships are pass-through entities, you’ll need to report any final income and distributions on your personal return.
If your partnership’s taxes are particularly complicated or you’re not sure what income and expenses to report, consider seeking legal advice from a tax attorney. (For more information, see our article on how partnerships are taxed.)
If your partnership has any assets left over, you should divide them among the partners according to each partner’s capital account. Your capital balance shows how much you’re entitled to from the partnership. For example, suppose your partnership has $10,000 remaining after paying off its debts. Your capital account’s balance is $7,000, and your partner’s account balance is $3,000. With its remaining balance, your partnership should pay you $7,000 and your partner $3,000.
If there’s not enough money left over to pay each partner’s full capital account balance, each partner should be paid proportionally to their share of the partnership’s distributions. Using our previous example, suppose the partnership has $5,000 left over. You and your partner’s capital accounts remain the same, with you being entitled to 70% of the partnership’s distributions and your partner being entitled to 30%. So, you’d be entitled to $3,500 and your partner would be entitled to $1,500 of the remaining $5,000 balance.
For more information, see our article on distributing remaining assets to owners when your business closes.
If you opened a business bank account for your partnership, you should close it. You should also cancel any business licenses or permits.
Partnerships represent an informal business relationship that usually requires little maintenance. Perhaps your dissolution and winding-up process will be just as simple. If so, then you and your partners can probably end your business yourselves.
But sometimes dissolving a partnership can be more work than starting or running one. If there’s a disagreement among the partners or a complicated list of debts, it can be a good idea to reach out to a business lawyer. They can help you work with your partners to resolve your obligations and end your liability.
]]>A partner might leave (or “dissociate” from) a partnership voluntarily or involuntarily. When a partner exits the business, the partnership can either continue or dissolve (end), depending on what the partnership agreement or state law allows or requires.
Business partners can decide to leave a business for many reasons:
Alternatively, a partner could be forced to exit the partnership. A partner might leave a partnership involuntarily when:
As part of deciding to go into business together, partners should decide what’ll happen if one of them leaves the partnership—whether voluntarily or involuntarily. The partners should make sure that whatever they decide on is accurately reflected either in the buyout provisions of their partnership agreement or in a separate partnership buyout agreement. Putting these terms into writing will help ensure a smooth and orderly transition for the partners when one is ready or forced to exit the partnership.
If you and one or more other people own and run a business together and you haven’t formed a corporation or limited liability company, then you have a general partnership. While not required, most business partners enter into written agreements that spell out the parties’ rights and responsibilities, including what happens if one person wants to leave the business.
One of the noteworthy characteristics of general partnership law is the extent to which the partners can establish their own rules for how the partnership operates. Except in certain circumstances, partners can agree to partnership terms that are different from those provided under state law. In general, state law is used to fill in gaps or serve as default rules where partnership agreements either don’t exist or are silent.
Most partnership agreements include provisions—called “buyout provisions”—that cover the basic issues that arise when one partner decides to withdraw. Instead of including these terms as provisions within a partnership agreement, some partnerships address these issues in separate partnership buyout agreements.
These provisions or agreements should answer questions such as:
If you have a partnership agreement that includes provisions about partner withdrawal, then those are the rules you should look to when a partner decides to leave the partnership. To the extent an issue isn’t addressed in your agreement, your state’s partnership laws will apply.
The modern sources of general partnership law are the Uniform Partnership Act (UPA) and the Revised Uniform Partnership Act (RUPA). Every state except for Louisiana has adopted either the UPA or the RUPA with approximately 41 states adopting the RUPA (or a variation of it).
Under both the UPA and RUPA, a partner has the right to withdraw from the partnership at any time, as long as proper notice (if required) is given. However, the UPA and RUPA have different rules about what happens to the partnership itself when a partner withdraws.
Partnership withdrawal rules under the UPA. Under the UPA, the withdrawal of a partner from the partnership automatically causes a dissolution of the partnership.
Partnership withdrawal rules under the RUPA. One of the major reforms introduced with RUPA was to allow a partner to withdraw without automatically causing a dissolution of the partnership. In most cases, under RUPA, a partnership can buy out the interest of a partner without ending the business. In addition, a partnership set up for a specific term won’t dissolve as long as at least one-half of the partners choose to remain.
Your partnership agreement or state law will determine what happens when a partner withdraws. In either case, the remaining partners and withdrawing partner have rights and obligations.
If a partner decides to voluntarily withdraw from the partnership, they’ll need to provide notice to the other partners. Your partnership agreement might provide additional restrictions. For instance, your agreement might require the notice be in writing and be given a certain number of days (for instance, 90 days) before the withdrawal takes effect.
When a partner involuntarily withdraws from a partnership, notice isn’t usually required because the partner isn’t making the choice to leave the business.
When a partner leaves and the business continues, the departing partner still has a share in the partnership. Unless the partner transfers their interest, the partnership will usually need to continue making distributions to the former partner. (For answers to specific question about buying a partner’s interest, see our article on buy-sell agreement FAQ.)
There are a few options for a departing partner’s interest in the business:
The partners will most likely prefer for the partnership or an existing partner to buy the other partner’s interest rather than risk someone outside of the partnership buying into the business. If the partners want to make specific rules for how a partner can be bought out, they should document these rules in the buyout provisions of their partnership agreement or in their partnership buyout agreement.
If the partners want to buy out the departing partner’s interest, then it’s a good idea to predetermine a price for the share. The partners can either decide on a price for each partner’s share beforehand or they can decide on a way to calculate a price for each partner’s share. Usually, the price for a partner’s share is determined by:
In a case where a partner has died, the partner’s estate or heir will be compensated for the deceased partner’s share.
Sometimes the partnership agreement or state law will require the partnership to dissolve when one partner leaves the business. The fate of the partnership might depend on how the partner left—whether voluntarily or involuntarily. For example, your partnership agreement might say that the business can continue if a partner retires but the partnership must dissolve if a partner dies.
If a partner’s departure triggers an end to the partnership, the partners will need to follow a dissolution procedure. In this case, the partnership will settle its debts and distribute any remaining assets to the partners—including the withdrawing partner—according to their capital accounts.
When a partner leaves, your business can be turned upside down. If you have a partnership agreement with a specific procedure for partner withdrawal, you can probably navigate the process yourself. But if you don’t have a written agreement or the terms in the buyout provisions are ambiguous, it can be a good idea to talk to a business lawyer. They can help you negotiate and draft a partnership buyout agreement and assess your rights in and obligations to the partnership.
]]>In limited partnerships (LPs), at least one of the owners is considered a "general" partner who makes business decisions and is personally liable for business debts. But LPs also have at least one "limited" partner who invests money in the business but has minimal control over daily business decisions and operations. The advantage for these limited partners is that they are not personally liable for business debts.
The limited liability partnership (LLP) is a similar business structure but it has no general partners. All of the owners of an LLP have limited personal liability for business debts.
In order to better understand LPs and LLPs, it's helpful to compare them to general partnerships.
In the business world, the word "partnership" usually refers to general partnerships. A general partnership is a business that has more than one owner and that has not filed papers with the state to create a specific entity such as a corporation or limited liability company (LLC). (Click here to learn more about general partnerships.)
In a general partnership:
A limited partnership has at least one general partner and at least one limited partner. The general partner has the same role as in a general partnership: controlling the company's day-to-day operations and being personally liable for business debts.
The role of limited partners, however, differs in a few ways:
Limited partners need to understand that they can become personally liable if they do not stick to their passive role. If a limited partner starts taking an active role in the business, that partner's liability can become unlimited. If a creditor can prove that a limited partner took acts that led the creditor to believe that he or she was a general partner, that partner can be held fully and personally liable for the creditor's claims.
Some states have carved out exceptions to this "active role in the business" rule. These exceptions usually allow a limited partner to vote on issues that affect the basic structure of the partnership, including the removal of general partners, terminating the partnership, amending the partnership agreement, or selling all or most of the assets of the partnership, without jeopardizing limited partner status.
Another kind of partnership, called a limited liability partnership (LLP) or sometimes called a registered limited liability partnership (RLLP), provides all of its owners with limited personal liability. LLPs are particularly well-suited to professional groups, such as lawyers and accountants. In fact, in some states LLPs are only available to professionals.
Professionals often prefer LLPs to general partnerships, corporations, or LLCs because they don't want to be personally liable for another partner's problems -- particularly those involving malpractice claims. An LLP protects each partner from debts against the partnership arising from professional malpractice lawsuits against another partner. (A partner who loses a malpractice suit for his own mistakes, however, doesn't escape liability.)
Forming a corporation to protect personal assets may be too much trouble. In addition, some states (including California) won't allow licensed professionals to form an LLC.
An LLC is similar to a limited partnership in that it provides liability protection to the owners of the business, and the owners have flexibility in deciding how the business will be managed. However, unlike limited partnerships, all of the owners of the LLC have limited liability protection. For more information, check out LLCs and Limited Liability Protection.
In addition, states typically have different formation paperwork for LLCs than for LPs. Further, while partnerships use partnership agreements to delegate rights and responsibilities, LLCs use operating agreements to outline the internal operating procedures.
To learn more about choosing between an LLC and an LLP, check out LLC vs. LLP: What Is the Difference?.
Creating a limited partnership or limited liability partnership is done at the state level. Each state has its own rules, but in general, you must pay a fee and file papers with the state, usually a "certificate of limited partnership" or "certificate of limited liability partnership." This document is similar to the articles (or certificate) filed by a corporation or an LLC and includes information about the general and limited partners. Filing fees for LPs and LLPs are similar to those for corporations and LLCs.
For more information on limited partnerships, including how to draft a limited partnership agreement, get Form a Partnership: The Complete Legal Guide, by Ralph Warner and Denis Clifford (Nolo).
]]>An LLP is an alternative partnership structure to general partnerships (GPs) and limited partnerships (LPs). Many states have created laws recognizing an LLP as a legal business structure. Texas became the first state to adopt a law permitting the creation of LLPs and about forty states now formally recognize LLPs.
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An LLP is a business formed between two or more partners. The partners can be individuals or other entities. Though LLPs are usually formed by a group of individual professionals. Common examples of LLPs include:
Some states, like California, allow only licensed professionals (like doctors and accountants) to form an LLP. Other states, like Texas, allow any group—regardless of their occupation—to form an LLP. So, you’ll need to check your state laws to determine if you’re eligible to form an LLP.
LLP vs. LLC. An LLP is often compared to a limited liability company (LLC) because the business structures share similar features. Both business types have limited liability for owners, flexible management structures, and pass-through taxation. But they also have notable differences such as their governing documents and the extent of owners’ limited liability. (For more comparisons, read about LLCs vs. LLPs.)
LLP vs. GP and LP. When compared to other partnership structures, LLPs can be seen as a blend of GPs and LPs. LLP partners have limited liability—just as limited partners have in an LP. But an LLP also allows each partner to participate in the business’s daily operations and decision-making—like a general partnership. (For more information, read about how the different partnership types compare.)
With all of the different types of business organizations to choose from, you might wonder why you would choose an LLP over other forms of business entities. Before deciding whether an LLP is the right choice for your business, you should consider its benefits and drawbacks.
If you’re eligible to form an LLP, you and your partners can take advantage of many of its benefits.
One main benefit of creating an LLP is a balance of management control with reduced liability exposure. Similar to a general partnership, an LLP allows its partners to actively participate in the operation of their business.
However, unlike general partners, partners in an LLP have limited liability. Typically, LLP partners only risk the money they invested into the business (their capital contributions) and don’t face unlimited personal liability for another partner’s mistakes. However, LLP partners are usually still liable for their own:
If an LLP partner doesn't use reasonable care in their professional activities or doesn't properly supervise their employees, then they could be personally liable for any injuries and costs that their negligence caused. So, the negligent partner would need to use their own funds to pay for these costs.
For example, suppose Barney and Fred are dentists and partners in an LLP. When treating one of his patients, Fred doesn’t review the patient’s records and mistakenly pulls out their four front teeth. The patient sues for negligence and the court awards the patient $50,000. Fred—not Barney—would be personally responsible for paying the $50,000 judgment.
Because each partner enjoys limited liability, some states require LLPs or the partners to carry minimum amounts of liability insurance. Your state’s laws also might require you to post a bond or other form of financial security to help protect the general public from possible liability claims.
In an LLP, each partner has the right to manage the business and has flexibility in shaping their role in business operations. LLP partners have a great deal of freedom in determining how the partnership will be managed.
The partners can agree to delegate daily business operations to a managing partner or to a committee made up of partners. Alternatively, they could decide to divide up duties based on:
To avoid confusion, it might be useful to develop an LLP agreement—also called a “partnership agreement”—to outline each partner’s role in the business.
As stated previously, state law controls the requirements for LLP formation. But generally, it’s relatively simple for eligible parties to create an LLP. State laws might also allow existing general partnerships to convert their partnership to an LLP.
To form an LLP, you’ll probably need to complete a registration form and file it with the relevant state agency, such as the secretary of state’s (SOS) office or corporations division. You can usually file the registration form online. You’ll probably need to pay a small filing fee.
As indicated above, it could be helpful to develop an LLP agreement to spell out each partner’s:
If your state has adopted LLP laws, you should make sure your agreement doesn’t violate any of these laws. Your LLP agreement will serve as the governing document for your business.
Typically, the LLP shares the limited liability of a corporation but avoids the double taxation associated with a corporation under IRS rules. Rather, LLPs are treated as “pass-through entities.” So, the LLP itself isn’t taxed as a separate entity under federal tax laws. Instead, the taxes pass through the LLP to the partners who report their share of the partnership’s profits and losses on their individual federal tax returns.
As an owner of a pass-through entity, you might be able to take advantage of the 20% pass-through tax deduction. Under this law, you’d only be taxed on 80% of your income instead of 100% of your income, which could result in significant savings.
Certain state laws might not permit pass-through taxation. Your state could impose a state franchise tax on the LLP business entity. Your local tax professional can help you sort out these complex tax issues.
While an LLP has many advantages, it also has some drawbacks.
State LLP laws can differ significantly from state to state. Some states don’t recognize LLPs as legal business entities at all. For the states that recognize LLPs, there can be different requirements regarding:
This lack of uniformity can make it difficult to interpret your own state’s laws. Additionally, if you want to register your LLP in a second state, you might need to comply with multiple sets of state laws that vary significantly.
Generally, LLP partners have limited liability. Typically, partners are only liable for their own actions and debts. But a partner’s degree of liability can vary from state to state.
A partner’s personal liability usually lands on a liability spectrum. In addition to liability for your own negligence and wrongdoing, you might also be personally liable for:
Your liability for employees’ actions also varies from state to state. You should review your state’s LLP laws to determine the extent of your personal liability.
Your ability to form an LLP will depend on your state. If your state recognizes LLPs and you qualify to form one, then you'll generally follow the same steps that you would when forming an LP.
Name your LLP. State law usually requires that the name of your LLP include the appropriate entity designation. For example, California requires your business name to end in "Limited Liability Partnership," "registered Limited Liability Partnership" or a corresponding abbreviation. (Cal. Corp. Code § 16952 (2023).) In Texas, you can use "Limited Liability Partnership" or an abbreviation of the phrase. (Tex. Bus. Org. Code § 5.063 (2023).) For more information, check out our article about FAQ on choosing a business name.
Designate a registered agent for your LLP. Most states, including California, require you to have a registered agent that can accept official papers on behalf of your business. The registered agent must have a physical street address in the state you're registering with. The agent can be an individual (like an employee) or a company. In Texas, you're not required to have a registered agent.
Prepare a partnership agreement. Generally, you're not required to have a partnership agreement, but it's always a good idea to have one. An agreement lays the foundation for how your LLP will be managed and operated and how profits and losses will be split. You don't need to file the agreement with the state.
Obtain an EIN. An LLP is a separate legal entity from its individual partners. Therefore, your LLP must obtain a federal employer identification number (EIN) from the IRS. You need an EIN for an LLP even if it has no employees. You can get an EIN by completing an online application on the IRS website. There's no filing fee.
Register to pay state taxes for your LLP. In some cases—for example, if you'll be collecting sales tax or hiring employees, you'll need to register with the appropriate state taxing authority. Additionally, some states require you to pay a minimum business tax or franchise tax to do business in the state.
Apply for a business license. Depending on what kind of business you are running and where it is located, you may need to obtain local or state business licenses for your LLP.
File annual reports and dues. Many states require businesses to file annual reports along with a fee to keep their company information up to date. States have different deadlines and requirements. For example, Texas requires you to file an Annual Report of a Limited Liability Partnership form (Form 703) by June 1 each year. Unlike many other states, California doesn't require LLPs to file an annual report. But you'll still be responsible for annual taxes.
Obtain malpractice insurance. Some states require you to have malpractice insurance, especially if you'll be providing professional services. You might even be required to have a minimum amount of malpractice insurance before you're eligible for protection from other partners' malpractice. Because professionals aren't protected from their own malpractice, if you're a professional you should make sure you have professional liability insurance—and, if applicable, that your coverage meets any state minimum insurance requirements.
In addition, some states require LLPs for some professions to adhere to additional rules—such as having partners keep up with professional registrations—in order for each partner to be eligible for protection from liability from other partners' malpractice.
The process for dissolving and winding up an LLP is very similar to that of an LP. Generally, you’ll:
For more detailed steps to follow, read how to dissolve a limited partnership.
If you’re interested in forming an LLP, contact your SOS or similar regulatory authority to find out more about your eligibility to create an LLP. If you’re looking for legal advice on whether forming an LLP is the right choice for your business, consider talking to a business attorney. They can help you understand how the advantages of an LLP can best benefit your business. A business lawyer can also help you negotiate and draft an LLP agreement.
]]>You and your investors decide to form a limited partnership (LP). As a general partner, you’ll be in charge of the day-to-day business strategy and execution. As limited partners, your investors will be in charge of financial contributions.
An LP is a business entity that consists of at least one general partner and one or more limited partners. Typically, the general partner is an experienced businessperson who provides both financial resources and daily management skills to the partnership. A limited partner is an individual or business that offers only capital or financial resources to the business.
This business structure offers owners a unique opportunity. Some owners can be tasked with running the day-to-day operations and carrying out business obligations and objectives; other owners can take a back seat and fund those operations. This type of partnership can work well with a group where one person (the general partner) is personally invested in the business’s success and the other people (the limited partners) see the partnership as an investment.
Partners in an LP don’t just differ in what they contribute to the business. They also differ in their level of liability for the partnership’s debts:
But a limited partner can lose their limited legal liability if they become involved in directing or operating the business. If a limited partner becomes more than an investor and contributes to the daily activities of the business, they can become a general partner and be personally liable for the LP’s debts.
A general partner is subject to unlimited personal liability because of their authority over daily business decision-making. If there’s more than one general partner in an LP, general partners are jointly and severally liable for the partnership’s debts and liabilities and debts—that is, each general partner is entirely responsible for the company’s debts.
For instance, suppose Lois and Lana are general partners in an LP. The LP has $100,000 in debts. Lois and Lana use the limited partners’ investments to pay off some of the debt, leaving $70,000 to be paid. The LP’s creditors decide to sue Lana, and the court orders her to pay $70,000 since she’s a general partner.
Usually, partners have a partnership agreement that lays out how much of the business’s debts each partner is responsible for. For example, the agreement might say that the general partners are equally responsible for the business’s debts. If one partner is ordered to pay the business’s full debt, but under their partnership agreement they’re only responsible for half of that debt, they can recover the other half from their business partner.
In an LP, general partners have certain fiduciary duties to the partnership because they’re responsible for the management and operation of the company. Limited partners don’t typically owe these duties to the LP.
General partners have the following fiduciary duties:
For more information, read our article on fiduciary duties in partnerships.
General and limited partners in an LP don’t share profits and losses equally. Traditionally, each partner’s profits and losses are determined by the value or percentage of any capital contributions made to the business.
However, the partners could decide to deviate from this traditional approach through their partnership agreement. It’s common for LPs to allocate a greater percentage of the business’s profits to limited partners until they’re paid back what they initially invested. Once limited partners get back their initial investment, partnerships often distribute the profits more evenly.
For example, suppose Fred is a general partner and Daphne and Velma are limited partners in an LP. Daphne and Velma each initially contribute $15,000 to the partnership. The partners decide to distribute a higher percentage of the profits to Daphne and Velma until they recover their initial contributions. So, at the start of the business, the partners decide on the following profit distribution:
A year into the partnership, Daphne and Velma have each received $15,000 in profit distributions—the same amount they each initially invested. Their partnership agreement states that once Daphne and Velma are paid back their investments, the profits will be distributed in the following way:
Though general partners don’t generally contribute as much as limited partners financially, they pull their weight through their labor and personal liability risk. Therefore, it’s not unreasonable for general partners to see the value they bring to the business returned to them in profits.
There are three main types of partnerships:
Each type of partnership differs in how owners share in the business’s responsibilities, profits, and liabilities.
LPs vs. GPs. LPs have general and limited partners whereas GPs only have general partners. General partners in a GP, like those in an LP, are personally liable for the business’s debts and are responsible for the company’s day-to-day operations.
LPs. vs. LLPs. An LP has general and limited partners whereas an LLP only has limited partners. The partners in an LLP manage and operate the business and have limited liability for business debts. In contrast, partners in an LP either manage the business’s daily activities or have limited liability. For more information, read our article on LPs vs. LLPs.
An LP's structure offers owners many benefits. But both general and limited partners face some drawbacks under this type of business. You should consider these factors when deciding whether an LP is right for you and your business.
An LP offers several benefits:
An LP isn't without its downsides:
Forming an LP is very similar to forming a GP. The main difference is that you’ll need to submit formation filings to the state to form an LP. Whereas with a GP, you form it just by going into business with someone else—no paperwork is needed. To learn the steps necessary to form a partnership, read our article on how to form a partnership.
You should take the following steps to form an LP:
(For a checklist, see our article on how to start a business.)
To end your LP, you’ll need to vote to dissolve the partnership and file the appropriate forms with your state. You’ll also need to wind up your business by:
For more information, see our article on how to dissolve an LP.
Limited partnerships can be a good option for a group where one person is interested in managing the business while the others are only interested in collecting passive income. If you have experience with running a small business, you might be able to create and manage your LP on your own.
But because the roles in an LP are so varied, it might be helpful to talk to a business lawyer about your and your partners’ responsibilities and liabilities. An attorney can help you decide whether an LP is the best choice for you. They can also help you negotiate and draft a partnership agreement, apply for the appropriate business licenses and permits, and assess your personal liability for your partnership’s debts.
]]>Here are a few reasons why you should have a separate bank account for your business:
The documentation needed to set up the account will depend on how your business is organized: sole proprietorships require somewhat different documents from LLCs, and so on. Let’s briefly look at what’s needed for sole proprietorships, general partnerships, LLCs, and corporations.
For a sole proprietorship, you might not need anything more than a social security number—or, if you have obtained one, a federal taxpayer identification number (TIN). However, if your business requires a government-issued license, or you’ve filed a business name certificate because your business operates under a name different from your own name, you will also need the license or certificate showing both the business name and your own name.
For a general partnership, you’ll need the partnership’s TIN, a copy of your partnership agreement showing the name of your business and the names of the partners, and a business name certificate showing the business name and partners’ names.
For a limited liability company, you’ll need the company’s TIN and a copy of the articles of organization (or, depending on the state where the LLC is organized, the equivalent document, such as a certificate of formation). If the articles of organization do not provide sufficient information regarding who is authorized to sign on behalf of the LLC, you may also need an additional LLC document that does provide that information.
For a corporation, you’ll need the TIN and a copy of the articles of incorporation (or, depending on the state where the corporation is formed, the equivalent document, such as a certificate of incorporation). If the articles of incorporation do not provide sufficient information regarding who is authorized to sign on behalf of the corporation, you may also need an additional corporate document that does provide that information.
The common theme here is that you need the basic documents that substantiate the name and general nature of your business, the fact that your business is somehow registered with the IRS, and that you, personally, have the authority to set up the bank account.
With the appropriate documentation in hand, you’ll need to decide what kind of bank account you want to open. More specifically, you may have options ranging from basic checking accounts that, under certain conditions, incur no monthly fees, to more expansive accounts that include additional features such as special cash management services to assist you in moving money between multiple accounts, special customer service and support, or free companion savings accounts. Regardless of the type of account you choose, you probably will also want to get a debit card for your business account. This can make it easier to pay at least some business expenses.
In many cases, you can open your account online without having to appear personally at the bank. However, some types of businesses cannot open accounts online. These include businesses that provide money services, such as check cashing, issuing money orders, exchanging currency, and wiring funds, and also telemarketing businesses, dealers in precious metals, gambling businesses, and government entities.
If you are changing the legal form of an existing business, for example from a partnership to an LLC or corporation, it’s a good idea to open a new account for the business in its new legal form. You should have your new taxpayer ID number for the business in its new form, which you can present to the bank along with the articles of organization or articles of incorporation, and any other documents that may be required. (If you choose not to establish a new account for your business in its new legal form, you will need to investigate what the bank requires to convert your existing account, and also keep careful track of checks and other records relating to your business before and after it changes form.)
Going forward, it’s important to manage your business bank account responsibly. One potential benefit of consistently maintaining an adequate balance in your account, not writing bad checks, and sticking with the same bank over time is that you will increase your chances of obtaining a business loan from your bank should that become necessary.
Opening a separate bank account is just one of many steps for starting a new business. For more information, check Legal Guide for Starting & Running a Small Business, by Fred Steingold (Nolo) and The Small Business Start-Up Kit: A Legal Guide, by Peri H. Pakroo (Nolo).
]]>If you've considered starting a business, you might've thought about forming a partnership. But what is a partnership, how does it differ from other business structures, and how do you start and run one? Read on for answers to all of your frequently asked questions.
A partnership is a business owned by two or more people that haven't filed papers to become a corporation or a limited liability company (LLC). You usually don't have to complete any paperwork to create your partnership—the arrangement begins as soon as you start a business with another person.
Although the law doesn't require it, many partners work out the details of how they’ll manage their business in a written partnership agreement. If you don't create a written agreement, the partnership laws of your state will govern your partnership.
As with any new business, you’ll need to comply with licensing and tax requirements. To learn the steps to create a partnership, see our article on how to form a partnership. (If you’re interested in educating yourself further on partnerships, check out Form a Partnership: The Complete Legal Guide by Denis Clifford and Ralph Warner.)
Unlike corporations, partnerships are relatively informal business structures. Partnerships aren't required to hold meetings, prepare minutes, elect officers, or issue stock certificates.
Generally, partners share equally in the management of the partnership and in its profits and losses. General partners will also usually assume equal responsibility for the business’s debts and liabilities. You should record the rules for the partnership in a partnership agreement.
You’re not legally required to create a written partnership agreement, but it's smart to do so. If you don't make a partnership agreement, you run the risk that the default rules in your state's partnership laws will govern your partnership in ways you and your partners won't like.
Creating a written partnership agreement will also give you and your partners a chance to:
You don't have to spend a fortune on lawyers’ fees to create a valid agreement—you and your partners might be able to put together a simple, clear agreement yourselves. But if you’re not sure what rules to include in the agreement or there’s a dispute among the partners, it could be a good idea to consult a business lawyer.
A partnership isn’t considered a separate entity from its partners for tax purposes. Generally, the partnership itself doesn’t pay any income taxes. Instead, partnership income "passes through" the business to each partner, who then reports their share of business profits or losses on an individual federal tax return.
Each partner will need to estimate the taxes they’ll owe at the end of the year and make four quarterly estimated tax payments to the IRS. As owners of a pass-through business entity, partners in a partnership might qualify for the 20% pass-through tax deduction created under the Tax Cuts and Jobs Act.
Your partnership might owe taxes to your city or county. If you sell goods or services, you might have to collect and pay sales tax to your state or local government. You should check with your state and local tax agencies to find out:
For more on reporting and paying partnership taxes, see our article on how partnerships are taxed.
Legally, a partnership is inseparable from its owners. As a result, each general partner is personally liable for the entire amount of any business-related obligations. So, if you form a general partnership, creditors can come after your personal assets (such as your house or car) to make sure any partnership debts get paid.
In a limited partnership (LP) and limited liability partnership (LLP), limited partners aren’t personally liable for all of the business’s liabilities.
Personal liability for LPs. An LP is made up of general partners and limited partners. In an LP, general partners are personally liable for all business debts while limited partners are only responsible for their financial investment. For example, suppose Adrian is a limited partner in her LP and contributes $5,000 to the partnership. The partnership struggles and can’t pay back a $20,000 loan. The LP could use Adrian’s $5,000 investment to pay off part of the $20,000 loan. But the lender can’t go after Adrian personally to pay the rest of the loan.
Personal liability for LLPs. For an LLP, all partners have limited liability. Each partner is only responsible for their financial investment and for their own actions and wrongdoings. For example, suppose Joey, Chandler, and Monica run a law firm as an LLP. Joey mismanages a client’s case, and the client sues for malpractice. The client wins the case and the court orders the firm to pay the client $20,000. Joey—not Monica or Chandler—would be responsible for paying the $20,000 court judgment because his actions caused the malpractice lawsuit.
In a partnership, you’re legally bound to any business transactions made by you or any of your partners, and you can be held personally liable for those actions. For example, if your partner takes out an ill-advised high-interest loan on behalf of the partnership, you can be held personally responsible for the debt.
In contrast, owners of LLCs and corporations aren’t personally liable for business debts.
For more information about limited liability, see our articles on LLC basics and corporation basics.
Before you go into business together, you and your partners should decide what will happen to the partnership when one partner exits the partnership. A partner can leave the partnership for many reasons. They could retire, die, or want to leave the partnership for some other reason, such as a divorce or bankruptcy. If a partner leaves, you and the remaining partners will need to know whether the partnership can continue and what to do with the departing partner’s share of the partnership.
You might feel like you're being overly cautious or pessimistic, but it almost always makes sense to include buyout—also called "buy-sell"—provisions in your partnership agreement to deal with the issues that result from a partner’s exit. Putting these terms in writing at the start of the partnership is the best way to prevent resentment and serious problems (including messy lawsuits) from cropping up later on.
If you and your partners don’t have an agreement, then state law will determine the fate of your partnership.
When one partner dies, the partnership can either end or continue. What happens to the partnership and the deceased partner’s share will depend on your partnership buyout agreement (or the buyout provisions of your partnership agreement). If you and your partners haven’t agreed on what happens if one partner dies, then you’ll need to follow your state’s partnership laws.
A common outcome when one partner dies is that the partner’s share of the business is passed on to the deceased partner’s beneficiary or heir. If someone inherits an interest in the partnership, you might have a few options:
If you don’t have an agreement in place, your state’s laws will usually either require the partnership to end or allow it to continue. If your partnership must dissolve, then you’ll need to settle any debts and distribute the remaining assets. The deceased partner’s estate will be entitled to the deceased partner’s share of the assets. The deceased partner’s share is determined either by the partnership agreement or by state law.
For example, suppose a business has four partners and one dies. The partnership agreement says that all four partners must share equally in the business’s assets. The remaining partners vote to end the partnership, as allowed by their partnership agreement. After selling off the partnership’s physical assets and settling debts, the business is left with $80,000. So, the three remaining partners and the deceased partner’s estate will each receive $20,000, or one-fourth of the partnership’s assets.
For more information, check out our FAQ on buy-sell agreements.
When two or more people go into business together, they've automatically formed a partnership; they don't need to file any formal paperwork. By contrast, to form an LLC, business owners must file formal articles of organization—sometimes called a certificate of organization—with their state. If you have an LLC, you’ll usually need to comply with other state filing requirements, such as submitting annual reports and paying registration and maintenance fees. You typically file your paperwork with the secretary of state’s office or corporations division.
Aside from formation requirements, the main difference between a partnership and an LLC is the personal liability of business owners. In a partnership, general partners are personally liable for all business debts. So, creditors can go after the partners' personal assets to satisfy the partnership’s debts.
In contrast, members (owners) of an LLC aren’t usually personally liable for the company's debts and liabilities. However, in some cases, LLC members can be personally liable for the business’s debts, such as when a member personally guarantees a business loan or the corporate veil is pierced.
There’s a similarity between LLCs and partnerships that’s important to note, however. Both business structures offer "pass-through" taxation. This form of taxation means that the owners report business income or losses on their individual tax returns; the partnership or LLC itself doesn’t pay taxes. And both partnerships and LLCs are eligible for the 20% pass-through deduction created by the Tax Cuts and Jobs Act.
For more information, read our articles on partnerships and LLCs.
Usually, when you hear the term "partnership," it refers to a general partnership—that is, one where all partners participate to some extent in the day-to-day management of the business. Limited partnerships are very different from general partnerships, and they’re usually set up by companies that invest money in other businesses or real estate.
While limited partnerships have at least one general partner who controls the company's day-to-day operations and is personally liable for the business’s debts, they also have passive partners called limited partners. Limited partners contribute capital (investment money) to the business but have minimal control over daily business decisions or operations.
In return for giving up management power, a limited partner's personal liability is capped at the amount of their investment. In other words, the limited partner's investment can go toward paying off any partnership debts, but the investor's personal assets can’t be touched—this is called "limited liability." However, a limited partner who starts tinkering with the management of the business can quickly lose limited liability status.
Doing business as a limited partnership can be at least as costly and complicated as doing business as a corporation. For instance, complex securities laws often apply to the sale of limited partnership interests. Consult a lawyer with experience in setting up limited partnerships if you're interested in creating this type of business.
To dissolve your partnership, you and your partners will need to agree to end the partnership. Usually, you’ll need to vote to dissolve the business. But sometimes, another event (like a partner’s death or withdrawal) will trigger the partnership’s dissolution. You should look at your partnership agreement for specific instructions on how to dissolve your partnership. If there are no instructions or you don’t have an agreement, follow your state’s laws.
How you officially dissolve your partnership will depend on which type of partnership you have. If you have a general partnership, then you don’t need to file any dissolution papers with your state. But if you have an LP or LLP, you’ll probably need to submit a dissolution filing—sometimes called a “statement of dissolution” or “certificate of dissolution”—to your state. Some states also require a small fee to dissolve your partnership.
Once you decide to end your partnership and submit the required filings, you’ll need to wind up your partnership. Winding up your partnership includes:
For more information on how to close your partnership, see our section on going out of business.
Yes. Any business—even partnerships and sole proprietorships—can have employees. If you have employees or plan to have employees, you’ll need to follow various employment laws. For information on what rules to follow and steps to take as a new employer, read our article on hiring your first employee.
A partner’s capital account shows their equity in the business. Capital accounts fluctuate as the business experiences profits and losses and money is distributed to the partners.
Every partner’s capital account starts out with the partner’s initial investment in the business. For example, if you invested $3,000 to start the business, then your capital account would begin at a positive $3,000. As of that moment in time, if the business were to be liquidated, you should receive $3,000 from the partnership.
Your capital account will certainly increase and decrease throughout the life of your partnership. If the business makes money, then your capital account will increase; if it loses money, then your account will decrease. When distributions are made to you as a partner, your capital account decreases because the partnership has paid you some of the money you’re entitled to.
Capital accounts are meant to track how much each partner is entitled to if the partnership were to end. But if your partnership is set to dissolve, you might not get all that’s in your capital account at that moment. The winding up of the business often eats into the profit that’s available to distribute.
When a partnership dissolves, each partner usually receives a share of the remaining partnership assets that’s proportionate to their capital account. (The partnership agreement or state law can specify a different arrangement, though.)
For instance, assume your capital account balance is $20,000 and your partner’s capital account balance is $10,000. Combined, the accounts hold $30,000, with yours representing two-thirds of that total and your partner’s representing one-third. Your partnership dissolves and is left with $15,000 in assets. According to the balances of your respective capital accounts, you should receive $10,000 (two-thirds of $15,000) and your partner should receive $5,000 (one-third of $15,000).
If you have experience creating and running a business and you feel comfortable with your state’s partnership laws, then you might not need to talk to an attorney. But many business owners find it helpful to reach out to a business lawyer at some point—whether at the beginning or end of the partnership—for legal advice. An attorney can help you draft a partnership agreement, assess your personal liability, and wind up your business.
You might also need more specific legal guidance. An employment lawyer can help you comply with your state’s employment laws, create human resource policies, and draft employment contracts. A tax attorney can help you file your tax returns and make sure you take advantage of all business tax deductions, including the 20% pass-through deduction.
If the IRS rejects your special allocation, it will tax you and your co-owners as if you had divided profits and losses in proportion to your ownership interests, regardless of what your partnership agreement or operating agreement says.
To be certain that a special allocation is legitimate, the IRS checks to see whether the allocation has what it calls "substantial economic effect." This jargon means that a special allocation must reflect the owners actual economic circumstances, not an effort to shift income around to reduce taxes.
John and Anna set up an LLC to operate their consulting business. John puts up all the cash, while Anna signs a promissory note to contribute her share in installments over the first two years of the business. Their operating agreement says that John and Anna each have a 50% ownership interest in the LLC, but it also says that John will be allocated 75% of the LLC's profits (and losses) for the first two years, and Anna will be allocated 25% of the LLC's profits (and losses) during this initial period. After the first two years, the agreement says that both members will split LLC allocations of profits and losses 50-50 -- that is, in proportion to their ownership interests. Because there are legitimate financial reasons for the uneven split, the IRS should respect this special allocation.
Unfortunately, the IRS regulations covering substantial economic effect are complicated. If you want to set up a special allocation, you'll need expert help to make sure that your allocation will pass muster with the IRS. A good accountant or tax lawyer -- one who provides advice on this area of tax law as a regular part of her practice -- can draft special language for your partnership agreement or operating agreement to ensure that the IRS will accept your special allocation.
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