A business partnership is a business entity that is formed in order to achieve specific business goals. Generally, a partnership is formed whenever two or more individuals form an organization together. In a partnership, each partner shares in the profits and gains as well as any losses.
Partners are permitted to contribute resources including:
- Assets; or
It is not relevant whether or not the individuals in a partnership were attempting to create one on purpose. The only important factor is that the parties intended to proceed as co-owners of a business for profit. This intention can be determined by examining two factors, including whether the parties shared in the profits and whether they have a right to control the business.
For example, suppose Person X and Person Y open a coffee shop. They make joint decisions about the coffee shop and split the profits. Even if they do not refer to themselves as partners, their business relationship meets the definition required to form a partnership. Although it is not required, most partnerships have a partnership agreement. A partnership may either be a general partnership or a limited partnership, depending on its goals.
When Can Partners Legitimately Dissolve a Partnership?
A partnership tends to be a less permanent business than other forms such as corporations. The reason for this is some partnerships are only formed for a specific business purpose. Once that purpose has been fulfilled, such as the creation of a joint product, the partnership may terminate.
Other reasons why a partnership termination or dissolution may occur can include:
- The death of one of the partners;
- The incapacitation of one of the partners;
- One of the partners files for bankruptcy. General partnerships typically dissolve immediately if one of the partners cannot proceed;
- A dispute has arisen between the partners;
- One of the partners has retired or is planning to retire; or
- The partnership has grown so large that the partners wish to incorporate it to form a more permanent business entity.
A partnership may also terminate according to specific terms outlined in a partnership agreement. A partnership may also dissolve by operation of law. This would include cases where the partnership is illegal or is found to be engaging in illegal activity.
What is the Difference between a General Partnership and a Limited Partnership?
One of the main differences between a general partnership and a limited partnership is that a general partnership will not dissolve immediately upon the death of a partner or a partner’s inability to continue participating in the partnership. In a limited partnership, however, a limited partner can withdraw from the partnership. The limited partnership continues because limited partners do not normally share in the responsibilities or management duties of the partnership.
A general partnership does not require any formalities to be considered a general partnership. It consists of two or more individuals who agree to own the business and make management decisions for the business. The partners share in any financial losses or profits of the partnership.
It is important to note that in a general partnership, each partner is individually liable for the debts of the business should it become unable to support itself. In addition, a partner in a general partnership may bring tort, contract, or criminal liability onto the other partner because each partner is considered an agent of the other.
The partners also have a fiduciary duty to act in the best interest of the partnership. In the event one partner breaches their fiduciary duty, the other partner may sue them for any damages resulting from the breach.
A limited partnership includes one or more general partners as well as one or more limited partners. One partner is required to be a general partner in a limited partnership. A general partner makes management choices for the business, while limited partners do not. The general partner assumes 100% of the risk for liabilities or debts of the limited partnership.
Limited partners only risk those financial contributions which they make to the limited partnership. Typically, all partners in the limited partnership share in the profits of the business.
Does a Partnership Pay Taxes?
Generally, a partnership does not pay taxes on the income that is generated by the partnership. A partnership is what the Internal Revenue Service (IRS) calls a pass-through entity. In this type of entity, the individual partners pay taxes on their share of the business income. In other words, the income passes through to the partners. The partners are required to report their shares of losses or profits on their own individual tax returns. In addition, partners must also pay self-employment tax on any partnership income.
How Does a Partnership End?
A partnership may end for a number of reasons, as noted above. The manner in which a partnership is officially terminated depends on the state laws governing the partnership, the type of partnership, and whether the termination is a dissolution or a dissociation.
A disassociation usually terminates the partner’s legal relationship with the partnership, including any profits or rights. If the partnership continues in the absence of the partner, the partnership must buy out the dissociating partner’s interest.
The dissolution process occurs when the entire partnership is terminated. A dissociation, in contrast, occurs when only one partner is attempting to end their association with the partnership.
In the dissolution process, any partner may dissolve the partnership at any time by providing a notice of dissolution. The partnership is then required to wind up its business activities and distribute its assets. Winding up includes the methods used to liquidate or distribute any property or assets remaining after the dissolution of a partnership.
The winding up process can begin in one of two main ways, by either a creditor petition or a partner’s petition. A creditor may petition to wind up an insolvent partnership in order to satisfy debt owed to the creditor by the partnership. A partner can petition to wind up the partnership if they do not believe the partnership has a sustainable future. This is only permitted if there are no bankruptcy petitions pending.
Only those partners that remain in the partnership have the right to any partnership assets during the winding up process. The winding up procedure may requires the partnership to:
- Collect any remaining business assets;
- Settle any remaining debts owed to non-partner creditors; and
- Distribute the remaining assets to the remaining partners.
Any funds resulting from the wind up stage are first used to pay off any outstanding debts of the partnership. Any remaining funds will be distributed to the partners individually. This distribution is typically based on their ownership interest in the partnership. In addition, the partnership should notify state and federal tax authorities, creditors, and clients, that the partnership is dissolving.
The winding up process usually occurs after the dissolution of the partnership. It is similar to a liquidation of a partnership. In many cases, if the partners decide there is no sustainable future for the partnership to continue, they decide to proceed with the winding up process.
Should I Hire a Lawyer for Help with Partnership Laws?
Yes, it is essential to hire an experienced corporate lawyer for help with partnership laws. Dissolving or terminating a partnership may have major consequences for the business interests of the partners.
An attorney can provide advice on your options for dissolution or termination. Your attorney can also inform you of the laws in your state. A lawyer will guide you through the process of dissolution and represent you during any court proceedings, if necessary.