Choosing the Proper Foundation: Partnerships 

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Allison Harrison

As with other business structures, partnerships can have pros and cons depending on the parties involved. Each partner will contribute to all aspects of the business, this includes, money, property, labor, and skill.  As a result, each partner will share in the losses and profits of the business. Before determining the structure of your business,  you must consider asset protection.

Partnership Basics 

There are four categories of Partnerships:

  • General Partnerships (“GP”): The GP is the most standard form of partnership. Unlike other types of partnerships, a mere oral agreement may create a GP. The partnership is owned and operated by general partners. Any capital provided by a partner will become an asset of the business.
  • Limited Partnership (“LP”): . General partners manage the LP with the limited partners having no rights to participate in the control of the business. General partners run the company and have unlimited liability. Limited partners do not have control over the enterprise and as a result are not subject to limited liability.
  • Limited Liability Partnership (“LLP”): An LLP is a for-profit business with two or more owners that have filed a statement of qualification with a state’s secretary of state. An LLP is a GP that has elected LLP status under the applicable provision of the GP statute. Unlike partners in a GP, partners are not personally liable for the obligations of the LLP.
  • Limited Liability Limited Partnership (LLLP): An LLLP is a limited partnership where the limited partners and the general partners get a full liability shield. An LLLP is simply an LP which has elected LLLP status under the applicable provisions of its limited partnership statute. The primary destination between a limited partnership and an LLLP is that the later provides a full liability shield for all partners.

Legal Formalities 

You may be in a partnership right now and not even realize it. The Uniform Partnership Act provides that a partnership is a business created automatically when two or more persons engage in a business enterprise for profit. Interestingly, partnerships are the only business entities that can be formed by oral agreement. But, as history and tradition have shown, oral agreements are not the most structurally sound deals. Importantly, a Partnership Agreement reduces your oral understandings to writing.

Most states have GP and LP statutes that set out general rules governing all forms of partnership. However, the partners have the power to override most of the state’s partnership act to reflect how to manage the partnership along with how profits and losses are allocated and distributed. This document is known as the partnership agreement. Absent a validly executed partnership agreement, a state’s partnership laws will govern the partnership. Be advised, some of these laws will lead to unfavorable legal repercussions. The partnership agreement prevents future misunderstandings by laying out the exact stipulations of the partnership. The law regarding Partnerships fluctuates greatly because each partnership will revolve around a different partnership agreement, subsequently allowing courts to swing in many different directions.

 

General Tax Implications 

A partnership pays no income tax. The earnings or losses flow through to each partner who will report this flow on the partner’s individual tax return. Although losses flow through to the partners based on the loss-sharing arrangements in the partnership agreement, many limitations restrict the partner’s ability to deduct the losses on their personal tax returns.

 

Proper Avenue 

  • General Partnership: Any losses or obligations incurred by the business are inseparable from the partners as individuals. Therefore, if creditors come after your business assets they have unlimited access to your personal assets. Since this is the default partnership, there are no requirements for organizing and planning details, many GP’s blows off important documents such as the partnership agreement, rendering the business unstable. If you want your business to succeed it is strongly advised to avoid a GP at all costs.
  • Limited Partnership: A limited partner’s liability for the partnership’s debt is limited to the amount of assets (Property or Money) that individual partner contributed to the business. Since limited partners enjoy a shield from liability, the general partners eat the burden of all the business debts and obligations. The general partners will assume the day to day operations without needing to consult limited partners. Often, a limited partnership may offer investors the opportunity to benefit from the profits and share in the losses of your business without the legwork of running your business.  In theory, your limited partner’s act as your investors, this means there are strict compliance issues involved. Therefore it is imperative that you have a detailed partnership agreement and hold annual meetings
  • Limited Liability Partnership: The LLP shields partners from liability for the misconduct of other partners. Some state’s place restrictions on an LLP’s scope of business. For example, some states limit the purpose to that of practicing a licensed profession. Licensed professions include businesses such as law offices and accounting firms. Aside from state limitations, if you intend to offer professional services there may be restrictions in place by your professions regulatory board.
  • Limited Liability Limited Partnership:  The  LLLP’s limited liability shields are similar to that of a shareholder of a corporation. Here, the partnership effectively shields the partners from responsibility for the actions of the business. Although only a few LLLP statutes expressly contemplate the doctrine of piercing the veil, the piercing will nonetheless be part of the law applicable to all LLPs. A court will pierce the veil and hold partners personally liable for the actions or debts of the LLLP if it the partners were using the partnership to conduct illegal activity.

 

Conclusion 

A GP is risky because business creditors can reach into your personal assets, as well as your business assets. Therefore, if a partnership is an attractive business structure for you, it is recommended to form a limited partnership (“LP”), limited liability partnership (“LLP”) or a limited liability limited partnership (“LLLP”).

A business is like a marriage. In a marriage, a couple will accumulate all of the qualities of each person and form a unit. In a partnership, the thought of collecting equipment, ideas, expenses and networking circles can be tempting. Be advised that a weak relationship can be devastating to a new business. Be sure to do the legwork and understand the people you are potentially going into business with, taking the time now can work wonders for your business in the long run.

This blog is intended to bare bones introduction concept and options surrounding Partnerships. It is not intended as legal advice, nor is it designed as an in-depth guide to forming your business entity. If you have questions about how to structure your business or issues regarding your already established business, please contact attorney Chad A. Hirschauer at (614) 440-1395 or chirschauer@alharrisonlaw.com.

 

IRS Circular 230 disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (a) avoiding penalties under the Internal Revenue Code or (b) promoting, marketing or recommending to another party any transaction or matter addressed herein.

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