An unincorporated organization with two or more members is generally classified as a partnership for federal tax purposes if its members carry on a trade, business, financial operation, or venture and divide its profits. However, a joint undertaking merely to share expenses is not a partnership. For example, co-ownership of property maintained and rented or leased is not a partnership unless the co-owners provide services to the tenants.
If your business will be owned and operated by several individuals, you should take a look at structuring your business as a partnership. Partnerships can be organized as a general partnership or a limited partnership. In a general partnership, the partners manage the company and assume responsibility for the partnership’s debts and other obligations. A limited partnership has both general and limited partners. The general partners own and operate the business and assume liability for the partnership, while the limited partners serve only as investors, and have no control over the company and are not subject to the same liabilities as the general partners.
One of the major advantages of a partnership is the tax treatment it enjoys. A partnership doesn’t pay tax on its income but passes through any profits or losses to the individual partners. At tax time, each partner indicates his or her share of partnership income, deductions and tax credits. In addition, each partner is required to report profits from the partnership on his or her individual tax return.
Personal liability is a major concern if you use a general partnership to structure your business. Similar to a sole proprietorship, general partners are personally liable for the partnership’s obligations and debt. In addition, each general partner can act on behalf of the partnership, take out loans and make business decisions that will affect and be binding on all the partners (if the general partnership agreement permits). Keep in mind that partnerships are more expensive to establish than sole proprietorships because they require more extensive legal and accounting services.
An essential protection you should provide yourself when entering into a partnership is a Partnership Agreement. This Agreement is much like a pre-nuptial agreement in a marriage. And, breaking up a partnership is often as traumatic and costly as breaking up a marriage. Although I am not an expert in these areas, and the following information in not intended to be used as a legal instrument, here are some guidelines for structuring your Partnership Agreement.
1. NAME AND BUSINESS
2. TERM (The partnership shall begin on ___and end . . . )
3. CAPITAL The capital of the partnership shall be . . .
4. PROFIT AND LOSS
5. SALARIES AND DRAWINGS
6. INTEREST ON CAPITAL
7. MANAGEMENT DUTIES AND RESTRICTIONS.
10. VOLUNTARY TERMINATION OF PARTNERSHIP