What Is a General Partnership?
When a sole proprietor takes on one or more partners, a general partnership is born. Because a sole proprietorship by its very nature can be owned by only one person, there is no exception to this rule. Occasionally, smart entrepreneurs create a general partnership agreement among the partners.
Like a sole proprietorship, no other paperwork is completed, and no filings need to be made for the formation to take place. All you have to do is start transacting business!
Even verbal agreements hold up in most states, so just because you don’t have the terms of your partnership in writing doesn’t mean that you aren’t held to them. Considering that the person most likely to sue you is your partner (or wannabe partner), the fate of your business depends on you keeping accurate written agreements with everyone you do business with from day one.
After all, if that person is willing to take you to court (you’d be surprised!), then he is likely also willing to embellish on any verbal “agreements” you may have made.
Even a non-membership-related agreement, which states that your business is taking on another individual for services but doesn’t make her a partner, should be executed in writing so that the ownership (or lack thereof) can’t be put up for interpretation later.
Even better, don’t take favors early on, and make sure to compensate those people who do work for you — especially when they don’t own any of the business. Otherwise, they can either claim that they were employees (and sue you for minimum wage and so on) or, even worse, try to claim ownership of your business — no matter what you’ve agreed to verbally or in writing!
Doubling the trouble by doubling the partners
As easy as a general partnership is to form, it’s equally easy to get into trouble. In a lot of ways, a general partnership is even more dangerous than a sole proprietorship. In a business organized as a general partnership, all the partners are jointly responsible for all the debts, judgments, negligent acts, obligations, and taxes of the business.
Not only are you held personally responsible for those things that you had a hand in, but you also are personally responsible for the acts of your partners! This holds true even for silent partners who aren’t aware of or involved in the day-to-day operation of the business.
All partners in a general partnership are held jointly and equally liable for the debts and obligations of the business. For example, say a partner at the deli you own wants to save a buck or two and, without your approval or knowledge, orders the weekly delivery of prosciutto from a shady supplier.
A few days later, a customer calls to tell you that his 5-year-old got a severe bout of food poisoning, landing her in the hospital. The angry parent sues your partnership. He not only has full recourse against the personal assets of the offending partner, but he also can seize your house, car, and other assets in order to satisfy the judgment.
Finding out other disadvantages
In addition to this added exposure to liability, general partnerships share all the disadvantages that sole proprietorships do. Like a sole proprietorship, a general partnership isn’t in any way separate from its owners. This means that your business cannot sell ownership interests in exchange for capital contributions and other forms of investment. This restriction makes raising any sort of formal financing close to impossible.
Another disadvantage to keep in mind is that the durability of the partnership is only as great as its weakest link. If one of the partners becomes disabled, goes bankrupt, or passes away, then the partnership goes with her.
Filing taxes with partnership taxation
General partnerships are subject to partnership taxation. This is a form of pass-through taxation, in which the profits and losses of the business flow through directly to the owners to be claimed on their personal tax returns. The partnership itself is not taxed. Instead, the partners are taxed on their share of the partnership income.
At the end of the business’s fiscal year, you simply file an information statement with the IRS, Form 1065, which lists all the income and expenses that the business incurred during that time frame.
After you total the amount of profit (or loss) that the partnership accrued, you issue each member a Form K-1, which lists the member’s share of the profits that he must pay taxes on (or losses that he can use to offset income from other ventures). You can generally divide the profits and losses among the partners however you want, as long as all the profit gets allocated.
General partnerships are subject to the same form of taxation that is the default for limited liability companies. However, the similarities end there. A general partnership is not considered an incorporated entity and offers zero liability protection for its owners.