Key takeaways
- A general partnership is the most common type of business partnership.
- General partnerships are easy to set up but bind you legally and financially to your partners.
- Create a partnership agreement to delineate the rights and responsibilities of each partner.
What is a general partnership?
A general partnership is an unincorporated business with two or more owners who share business responsibilities. Each general partner has unlimited personal liability for the debts and obligations of the business. Each partner reports their share of business profits and losses on their personal tax return.
General partnerships are common business entities because they're simple to establish and maintain, including for tax filing purposes.
How general partnerships work
In a general partnership, you don’t need to register your business with the state to legally operate. When two or more people go into business together with the goal of earning a profit, a general partnership exists by default.
To have a general partnership, two conditions must be true:
- 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.
Risks of general partnerships
Every partner can enter into contracts or business deals that are binding on every other partner. While this can be convenient, it also means that you should trust the person with whom you launch your company. Although it may be appealing to start a business with a friend or family member, they may not be the best choice as a business partner. Your partner’s actions or mistakes can affect you legally and financially.
General partnership agreements
To prevent and resolve disagreements, owners in most general partnerships create a partnership agreement or founders’ agreement. The agreement outlines the governing structure of the business and each owner’s rights and responsibilities. The agreement also typically addresses partner voting rights and the division of profits.
In the absence of a partnership agreement, general partnerships dissolve when one of the partners passes away, becomes disabled or leaves the partnership. An agreement can specify what should happen in these circumstances. For example, if one partner dies, the surviving partner or partners may have the first opportunity to buy out that individual’s share.
General partnership features
It doesn’t take much to create a general partnership, but once a partnership is established, the consequences can be significant, especially in terms of shared liability among partners.
Joint liability in a general partnership
The hallmark of a general partnership is shared liability for partnership debts and obligations. Every partner faces unlimited personal liability for three things:
- Their own actions.
- The actions of other partners that bind the partnership.
- The actions of company employees.
If someone sues a general partnership, the partners have shared responsibility for any damages a judge or jury awards. This is called joint liability.
Some states take this a step further with joint and several liability. In that case, a creditor or legal claimant can sue any partner for actions taken by other partners. It’s then the partners' responsibility to sort out who owes what. Shared liability in a general partnership can be particularly harmful if one partner is negligent or involved in criminal activity.
Example of joint liability in a general partnership
Let’s say Partners A, B and C own a landscaping company together. Partner A accidentally injures a client with a lawnmower while out on a job one day. The client sues all three partners and receives a large damages award of $1 million. In court, Partner A discloses having very few personal assets. In states that follow joint and several liability, the client can then recover the damages from the personal assets of Partner B and Partner C even though they had nothing to do with the lawnmower injury.
Later, Partners B and C can sue Partner A to recover money, but it might not be worth their time if Partner A doesn’t have any assets.
Fiduciary duties in a general partnership
Fiduciary duties can help protect owners in a general partnership. There are four types of fiduciary duties among general partners:
- Duty of Good Faith and Fair Dealing: 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 any known potential benefits and risks of a prospective business decision so the other partners can make an informed choice about whether to pursue it. Partners have to disclose information about business activities, finances and contracts.
- Duty of Care: Partners must use reasonable care when managing the partnership. For example, partners should document important business matters in writing and maintain accurate financial records.
These fiduciary duties arise from the moment the partnership starts and they continue until the partnership is dissolved. State law may specify additional fiduciary duties, but business owners can add to or modify certain fiduciary duties with a partnership agreement. If a partner breaches a fiduciary duty, the other partners can sue.
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 share of profits however you see fit.
- Some partnerships specify one or more 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 (RUPA) or the Uniform Partnership Act (UPA). These are model statutes that provides standard rules about how a partnership should be governed and the rights and duties of each partner. Under UPA, for example, 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, but not in the form of a salary because partners are not classified as employees.
- Partners receive distributions from the partnership’s profits, in line with their ownership share as outlined in the partnership agreement. If there is no agreement, profits are distributed equally among partners.
- The IRS considers distributions to be 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 are subject to an annual informational income tax return, as well as employment taxes (if the partnership has employees).
- 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.
- 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.
- Income for general partners is usually treated as self-employment income, so partners should attach Schedule SE to Form 1040.
- In addition, the partnership must file Form 1065 as an informational return with the IRS by March 15.
- Partners must pay federal taxes and, in most states, state and local income taxes. There may 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
Here are some of the pros and cons to consider for a general partnership.
Pros
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.
Cons
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?
A general partnership might be a practical way to start your business venture because it’s relatively easy and inexpensive.
Eventually though, your business may become too large or complex for a general partnership structure. When your business conducts many activities, deals and contracts, the likelihood that a mistake or oversight will occur may be more likely. And if it does, joint liability can be harmful to the business.
Other types of partnerships
As a business grows, consider a business structure that limits liability for owners, such as a limited partnership, limited liability company or corporation.
- 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.
A version of this article originally appeared on JustBusiness, a subsidiary of NerdWallet.
