Partnership Meaning | Partnership Definition
What is a partnership? A partnership is an informal business owned by more than one individual. The term partnership usually refers to a general partnership. In a general partnership, owners file taxes on their individual tax returns, and the partners are liable for any actions taken against the business.
Partnerships are popular because they are simple to start and maintain. Their startup costs are lower than other business structure types like LLCs and corporations, and there is much less paperwork.
While the term “partnership” usually refers to a “general partnership,” which is the informal business structure described above, it is not the only type of partnership.
Types of Partnerships:
- A general partnership (GP) is an informal business owned by more than one individual. GPs file taxes under the partners' names, and the partners are liable for any actions taken against the business.
- A limited partnership (LP) allows one or more partners to serve as passive investors rather than directly managing the company. Limited partners have personal liability protection.
- A limited liability partnership (LLP) provides some amount of personal liability protection to all of the partners.
- An LLC partnership is just another way of referring to multi-member LLCs.
Should I Form a Partnership?
A partnership could be a good option if your business has the following characteristics:
- You have multiple owners: Partnerships must have more than one owner.
- Your business is low-profit and low-risk: Because there is no personal liability protection with a partnership, there should be a low chance of financial loss.
- You have a small customer base: If your customer base goes beyond friends and family, there is increased risk.
- You started your business as a hobby: Partnerships are often a good option as you transition an activity from just a hobby to a small business.
If your business does not check each of these boxes, you may want to consider the advantages of forming an LLC.
How to Form a Partnership
Because a general partnership is not a separate legal entity from its owners, it generally does not require any paperwork to form one. Two people can start doing business together and automatically be considered a partnership. However, we recommend that partnerships create a partnership agreement.
A partnership agreement formally lays out the terms of the agreement between the partners to avoid potential confusion or conflict in the future. It can include several topics, but it should cover, at a minimum, the following:
- The percentage of ownership of each partner
- How partners will allocate profits and losses
- Who is authorized to sign contracts and other legal documents
- How partners will make major business decisions
- How partners will resolve disputes
- What happens following the death or departure of a partner
A partnership is considered a “pass-through entity” for tax purposes. In pass-through taxation, businesses are not taxed at the corporate level. Instead, the profits or losses pass through to each owner’s individual tax return.
This structure means there is no corporate tax rate and no partnership tax return — the rate owners pay on their share of the company’s profits is based on their personal tax bracket.
However, in addition to personal income tax, owners of partnerships and other pass-through entities must pay self-employment tax.
How to Start a Business
Once you have learned about the advantages and disadvantages of partnerships and decided if it is the right business structure for you, you will need to actually form and set up the business.
Whether you choose to form a partnership or some other structure, there are more things to take care of before you are ready to sell your products or services.
You can read these in more detail in our state-by-state How to Start a Business guides, but here is a quick rundown of some basic steps after forming your business:
- Register for taxes
- Create business banking and credit accounts
- Set up accounting
- Obtain permits and licenses
- Get insured
- Establish a web presence
What are the advantages of a partnership?
General partnerships are simple and inexpensive to start compared to corporations and LLCs.
What are the disadvantages of a partnership?
Some disadvantages of a partnership include the lack of personal liability protection, limited tax benefits, limited growth potential, and less credibility with customers and potential investors compared to a formal business structure.
What are the four types of partnerships?
The four different types of partnerships are general partnership (GP), limited partnership (LP), limited liability partnership (LLP), and LLC partnership or multi-member LLC.
What is a general partnership?
A general partnership (GP) is an informal business owned by more than one individual. GPs file taxes under the partners' names, and the partners are liable for any actions taken against the business.
What is a limited partnership?
A limited partnership (LP) allows one or more partners to serve as passive investors rather than directly managing the company. Limited partners have personal liability protection as long as they maintain their inactive role.
Limited partnerships typically have more startup requirements than a general partnership.
What is a limited liability partnership?
A limited liability partnership (LLP) provides some amount of personal liability protection to all of the partners. The limits of this protection vary by state. LLPs are required to have partnership agreements, and some states have additional requirements.
How are partnerships taxed?
A partnership is considered a “pass-through entity” for tax purposes. This structure means the company does not pay a corporate tax. Instead, the profits or losses pass through to each owner’s individual tax return.
What is a partnership agreement?
A partnership agreement formally lays out the terms of the agreement between the partners to avoid potential confusion or conflict in the future. This agreement can include the percentage of the company each partner owns and how the partners split profits.