Partnership: Definition, How It Works, Taxation, and Types (2024)

What Is a Partnership?

A partnership is a formal arrangement by two or more parties to manage and operate a business and share its profits.

There are several types of partnership arrangements. In particular, in a partnership business, all partners share liabilities and profits equally, while in others, partners may have limited liability. There also is the so-called "silent partner," in which one party is not involved in the day-to-day operations of the business.

Types of Partnerships

In a broad sense, a partnership can be any endeavor undertaken jointly by multiple parties. The parties may be governments, nonprofits enterprises, businesses, or private individuals. The goals of a partnership also vary widely.

Within the narrow sense of a for-profit venture undertaken by two or more individuals, there are three main categories of partnership: general partnership, limited partnership, and limited liability partnership.

General Partnership

In a general partnership, all parties share legal and financial liability equally. The individuals are personally responsible for the debts the partnership takes on. Profits are also shared equally. The specifics of profit sharing will almost certainly be laid out in writing in a partnership agreement.

Limited Liability Partnership

Limited liability partnerships (LLPs) are a common structure for professionals, such as accountants, lawyers, and architects. This arrangement limits partners' personal liability so that, for example, if one partner is sued for malpractice, the assets of other partners are not at risk.

Some law and accounting firms make a further distinction between equity partners and salaried partners. The latter is more senior than associates but does not have an ownership stake. They are generally paid bonuses based on the firm's profits.

Limited Partnership

Limited partnerships are a hybrid of general partnerships and limited liability partnerships. At least one partner must be a general partner, with full personal liability for the partnership's debts. At least one other is a silent partner whose liability is limited to the amount invested. This silent partner generally does not participate in the management or day-to-day operation of the partnership.

Finally, the awkwardly-named limited liability limited partnership is a new and relatively uncommon variety. This is a limited partnership that provides a greater shield from liability for its general partners.

Taxes and Partnerships

There is no federal statute defining partnerships, but nevertheless, the Internal Revenue Code (Chapter 1, Subchapter K) includes detailed rules on their federal tax treatment.

Partnerships do not pay income tax. The tax responsibility passes through to the partners, who are not considered employees for tax purposes.

Individuals in partnerships may receive more favorable tax treatment than if they founded a corporation. That is, corporate profits are taxed, as are the dividends paid to owners or shareholders. Partnerships' profits, on the other hand, are not double-taxedin this way.

Advantages and Disadvantages of Partnerships

A successful partnership can help a business thrive by allowing the partners to pool their labor and resources. Most sole proprietors do not have the time or resources to run a successful business alone, and the startup stage can be the most time-consuming.

Creating a partnership allows the partners to benefit from one another's labor, time, and expertise. Moreover, a shrewd partner can also provide additional perspectives and insights that can help the business grow.

But there is also an additional risk in joining a partnership. In addition to sharing profits, the partners may also assume responsibility for any losses or debts from the other partners. There is also a higher chance of conflict or mismanagement. When the time comes to exit, it may be harder to reach an agreement about selling the business.

Partnerships by Country

The basic varieties of partnerships can be found throughout common law jurisdictions, such as the United States, the U.K., and the Commonwealth nations. There are, however, differences in the laws governing them in each jurisdiction.

The U.S. has no federal statute that defines the various forms of partnership. However, every state except Louisiana has adopted one form or another of the Uniform Partnership Act; so, the laws are similar from state to state. The standard version of the act defines the partnership as a separate legal entity from its partners, which is a departure from the previous legal treatment of partnerships.

Other common law jurisdictions, including England, do not consider partnerships to be independent legal entities.

The Bottom Line

A partnership is a legal arrangement that allows two or more people to share responsibility for a business. Those partners share the ownership and profits, but they also share the work, responsibility, and potential losses. A successful partnership can give a new business more opportunities to succeed, but a poorly-thought out one can cause mismanagement and disagreements.