What Is a General Partnership? Pros, Cons & How to Form

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What is a general partnership?
Understanding general partnerships
- The company must have two or more owners.
- All partners must agree to have unlimited personal responsibility for any debts or legal liabilities the partnership might incur.
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General partnership features
Joint liability in a general partnership
- Their own actions.
- The actions of other partners that bind the partnership.
- The actions of company employees.
Example
Fiduciary duties in a general partnership
- Duty of Good Faith and Fairness: Partners must act honestly and fairly in all activities that affect the business.
- Duty of Loyalty: Partners should place the best interests of the partnership above their own interests and avoid any conflicts of interest that could hurt the partnership.
- Duty of Disclosure: Partners should disclose the potential benefits and risks known to them of a prospective business decision so that the partners can make an informed choice about whether to pursue it. Partners might have to disclose information about business activities, finances, contracts, etc.
- Duty of Care: Partners must use reasonable care when managing the partnership. For example, partners should document important business matters in writing and maintain books for financial transactions.
Management and control in a general partnership
- A partnership agreement can specify different areas of responsibility and different privileges for each owner.
- You can distribute voting rights and profit share however you see fit.
- Some partnerships specify a few managing partners to take the lead on business matters.
- One thing you can’t change with a partnership agreement is your state’s rules on joint liability or joint and several liability.
- In the absence of a partnership agreement, the majority of states follow the Revised Uniform Partnership Act, also known as RUPA or UPA. This is a model statute that provides standard rules about how a partnership should be governed and the rights and duties of each partner. Under RUPA, all partners have equal voting rights and profit shares, even if one partner contributes more resources or money to the company.
Compensation in a general partnership
- General partners are entitled to compensation for their participation in the partnership.
- Partners aren’t considered employees, so compensation isn’t in the form of a salary. Instead, partners receive distributions from the partnership’s profits, in line with their share of profits as outlined in the partnership agreement (profits are equally distributed if there’s no agreement).
- The IRS considers distributions as self-employment income, which is subject to self-employment taxes for Social Security and Medicare.
- The partnership can retain any money that’s not distributed and reinvest it in the company, but partners still have to pay taxes on retained earnings.
Taxes in a general partnership
- General partnerships don’t pay business income taxes, because they are pass-through entities. This means each owner reports their share of the partnership's income and losses on their personal tax return and pays the taxes accordingly.
- The partnership must complete and provide a Schedule K-1 to each owner no later than March 15 each year. Schedule K-1 summarizes each owner’s share of business income, losses, credits and deductions. Each partner uses the information in the Schedule K-1 to complete their Form 1040 tax return.
- Income for general partners is usually treated as self-employment income, so the partner should attach Schedule SE to their 1040.
- In addition, the partnership must file Form 1065 as an informational return with the IRS no later than April 15.
- In most states, partners must pay federal, state and local income taxes. There might also be other small-business tax obligations, such as payroll taxes and sales tax collection, depending on the specific circumstances of your company.
- Filing business taxes can be a multi-step process, so we recommend using a tax professional to complete your taxes.
Pros and cons of a general partnership
- Easy to start (no registration or incorporation required).
- The partnership doesn’t pay taxes (income and losses pass through to the owners’ personal tax returns).
- Compliance is relatively easy (e.g., no annual reports).
- Partners can customize management and control to some extent via a partnership agreement.
- Partners have unlimited personal liability for the actions of other partners and employees.
- Disputes among partners can cause the business to fail, particularly in the absence of a partnership agreement.
- This is not an appropriate business structure for raising investor money.
Is a general partnership right for you? Other types of partnerships
- LLCs and corporations limit personal liability for all owners of the business.
- In a limited partnership, there are two types of partners — general partners and limited partners. General partners have unlimited personal liability for business debts and obligations, but limited partners are only responsible up to the amount of their investments.
- Limited partnerships can be a good option when pooling the resources of multiple people or when a few partners bring capital to the table.