According to the key partnership statute, known as the “Revised Uniform Partnership Act (RUPA),” a partnership is an association of two or more persons to carry on a business for profit as co-owners. It does not matter whether or not the individuals were trying to create a partnership on purpose. It only matters that the parties intended to manage a business as co-owners.
This can be determined by two factors: (1) whether they share in the profits, and (2) whether they have the right to control the business. For example, suppose two people open a coffee shop. They split the profits and make joint decisions about the business. Although they do not refer to themselves as partners, their relationship meets the above definition, and they are partners.
Although no other legal formalities need to be met to create a partnership, almost all partnerships have a partnership agreement.
How Do You Make a Successful Partnership Agreement?
A good partnership agreement describes each partner’s relationship with the business. It also outlines each partner’s rights and obligations to the partnership. It may also include:
- The purpose of the partnership
- The amount or portion of the partnership owned by each partner
- The process for adding new partners
- Which partner(s) have the authority to make business decisions on behalf of the partnership
- The method the partners will use to resolve disputes
- How the partnership can be dissolved or transferred
- Any other policies or procedures that the partners have in place to make major decisions or handle important aspects of the partnership
The clearer and more detailed the partnership agreement is, the more likely it will be successful. The partnership agreement should provide a solution for every foreseeable and potential issue that could arise and harm the business. Knowing in advance what the partnership terms are helps strengthen the partnership itself5.
Partnership agreements may be formed orally or implicitly (by the partners’ actions); it is best to put the partnership agreement in writing. That way, the agreement may act as a reference to resolve disputes quickly or can be used as guidance to solve any future legal issues, should they occur. Moreover, if the partnership agreement is not in writing, disputes about the terms of the partnership are far more likely to crop up.
Who Has Control in a Partnership?
Control in a partnership can be determined by focusing on three primary factors: ownership, management, and the authority to do business. This is why it is so important to define these concepts and which partners they apply to in a partnership agreement.
In general, unless the partnership agreement states otherwise, all partners have equal rights to control the partnership. This means that decisions regarding day-to-day business operations require a majority vote of the partners. However, matters outside the scope of daily business decisions will require all the partners’ consent (e.g., selling the partnership).
Control in a partnership may also depend on the type of partnership formed and the laws of the state where the partnership operates.
Can I Face Liability in a Partnership?
There are various types of partnerships, and the amount of your potential liability depends directly on the type of partnership formed. Common types are:
- General Partnership: This is the most common type of partnership. The partners are co-owners of the business. General partners are individually and jointly responsible for losses or debts incurred by the general partnership, and for tort or contract law claims against the partnership.
- Limited Liability Partnership (LLP): Partners to an LLP have the same financial rights and obligations as a general partnership. However, they are free from the debts and liabilities of all of the other partners and certain debts and liabilities of the partnership. Forming an LLP requires filing with the state. Partners are liable for their own acts or any they supervise or direct. In other words, unlike general partners, they are not exposed to unlimited legal liability but only liability based on something they did, supervised, or directed. LLPs are similar to corporations in this sense.
In a limited partnership, there are two kinds of partners: general and limited. There must be at least one partner selected to be a general partner. A general partner makes management decisions, whereas a limited partner does not. Limited partners have limited authority over the partnership and are more like investors than general partnerships. In a limited partnership, the general partners are individually and jointly responsible for any liabilities or debts incurred by the partnership. In contrast, limited partners are only liable to the extent of their investment in the limited partnership.
Do Partnerships Pay Taxes?
In general, a partnership does not pay taxes on the income generated by the partnership. Instead, it is what the IRS calls a “pass-through entity.” This means that the individual partners pay taxes on their share of the business income; that is, the partnership income “passes through” the business to the partners.
The partners report their share of profits and losses on their own individual income tax returns. Partners are also required to pay self-employment tax on their partnership income.
How Do You End a Partnership?
Partnerships may end for a variety of reasons. Some of these include:
- One of the partners has already retired or is planning on retiring
- When one of the partners becomes deceased, incapacitated, or has filed for bankruptcy
- If disputes arise between the partners and they cannot be resolved;
- There may be specific terms set out in a partnership agreement that provides for a termination date
- The partnership has grown so large that the partners wish to incorporate it to form a more permanent business entity.
- By operation of law (e.g., the partnership is engaging in illegal activity and must be dissolved)
How a partnership is officially terminated may depend on the state laws governing the partnership, its type, and whether it is an actual dissolution or a disassociation.
The dissolution process refers to the termination of the entire partnership. Disassociation, on the other hand, is only used when one partner is attempting to end its association with the partnership. A disassociation generally terminates the partner’s legal relationship with the partnership, including any rights and profit. If the partnership continues in the absence of this partner, then the partnership must buy out the dissociating partner’s interest.
As for the dissolution process, any partner may dissolve the partnership at any time by providing a notice of dissolution. The partnership must then distribute or liquidate any property or assets remaining after the dissolution of the partnership. Debts must be paid first; the remaining funds will go to the partners individually. The partnership should notify state and federal tax authorities, creditors, and clients that the partnership is dissolving.
Do I Need a Lawyer to Form a Partnership?
You should consider hiring an experienced business partnership lawyer to form a partnership for many reasons. For one, a business lawyer can help you draft or review your partnership agreement to ensure that it is clear and includes any provisions that may be necessary to avoid future hardship.
A lawyer can help you decide which type of partnership is best for your business. Some formations of partnerships are better suited for specific businesses than others. The type you choose may determine the amount of taxes you and your partners will be responsible for and the liability risks associated with the partnership selected.
If you and your partner decide to form a limited partnership or a limited liability partnership, you will need a lawyer to draft a partnership agreement that creates the kind of partnership you have decided to form.
Finally, a lawyer can also assist with any disputes regarding the partnership and guide the partnership through the dissolution process.