What Is a Partnership and When Is It a Good Idea?

A partnership is simply a joint venture of two or more individuals conducting a business together for profit. Like the sole proprietorship, the partners are liable for the debts and liabilities of the business individually. Again, no formal organization is required, though a written partnership agreement is always recommended.

This type of business entity is essentially a creature of contract between the partners. A general partnership is an association of two or more people or entities conducting business together as co-owners for profit. Like the sole proprietorship, a general partnership can be informally formed. All that is required is an agreement by the parties to conduct business together as co-owners. At times, even the parties themselves do not realize that they have created a partnership.

Though a general partnership can be informally established, such partnerships usually end in a dispute. To avoid this result, a written partnership agreement establishing how the partnership will be managed and the profits divided is in everyone’s best interest.

A partnership, unlike a sole proprietorship, is an entity separate from the partners themselves for state law purposes. Therefore, the partnership may own property in its own name. However, the partnership is not a tax-paying entity. A general partnership is managed by its partners, although the partnership agreement can change this. Third parties may deal with any of the partners and any partner may bind the partnership.

All partners are individually liable for the debts and obligations of the partnership. The unlimited liability of a member of the partnership despite the ability for all partners to bind the partnership is the major drawback of this form of doing business, prompting many to opt for an LLC, limited partnership, or limited liability partnership instead.

For tax purposes, the partnership is treated as a flow-through entity. That is, the partnership does not pay tax but files an informational return showing the allocation of income and loss among the partners. The partners then must claim the income and loss on their own tax returns. This creates a single level of tax at the individual level that is appealing for many businesses. What many don’t realize, however, is that this single level of tax can be accomplished with other business forms without risking the liability inherent in the general partnership form.

Since all of the benefits of the partnership form, for tax purposes, can be obtained using other business forms while providing limited liability for the participants, a general partnership is rarely the entity of choice. If a partnership is proposed, the parties involved should consider creating a limited liability company instead, especially given the “check the box” regulations that simplify the taxation issues.

Skoubye, Nielson, Johansen Attorneys Salt Lake City Utah

Jeff B. Skoubye