Questions and answers about starting a partnership business with others.
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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.
Frequently Asked Questions on Partnership
- What's a partnership and how do I create one?
- Are there special rules for running partnerships?
- Is a written partnership agreement required for every partnership?
- How are partnerships taxed?
- Are owners of a partnership personally liable for business debts?
- What happens if one partner wants to leave the partnership?
- What happens to a partnership if one partner dies?
- What are the differences between a partnership and a limited liability company?
- What is the difference between a general partnership and a limited partnership?
- How do you dissolve a business partnership?
- Can a partnership have employees?
- What's a capital account in a partnership?
What's a partnership and how do I create one?
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.)
Are there special rules for running partnerships?
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.
Is a written partnership agreement required for every partnership?
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:
- discuss your expectations of each other
- define how each of you will participate in the business, and
- work out any sticky issues before they become major problems.
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.
How are partnerships taxed?
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:
- which goods and services are taxed
- the state and local tax rates, and
- your responsibilities for reporting and paying these taxes.
For more on reporting and paying partnership taxes, see our article on how partnerships are taxed.
Are owners of a partnership personally liable for business debts?
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.
What happens if one partner wants to leave the partnership?
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.
What happens to a partnership when one partner dies?
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:
- you, another partner, or the partnership itself can buy out the heir's share—usually for a previously agreed-upon price or for a price equal to the share's fair market value
- the heir can take over the deceased partner's duties as a partner and the partnership continue on as it did before; or
- the partners can vote to dissolve the partnership and compensate the heir (or the estate) for the deceased partner's share in the business.
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.
What are the differences between a partnership and a limited liability company?
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.
What's the difference between a general partnership and a limited partnership?
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.
How do you dissolve a business partnership?
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:
- notifying creditors, customers, and suppliers
- settling debts
- distributing assets
- filing final tax returns
- closing bank accounts, and
- canceling any licenses, registrations, and permits.
For more information on how to close your partnership, see our section on going out of business.
Can a partnership have employees?
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.
What's a capital account in a partnership?
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).
Consulting an Attorney
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.
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