Terminology Overview:

Dealing with Partnerships

Generally speaking, a partnership is a sole proprietorship with one or more additional owners. In general partnerships, each owner shares management of the business and liability for the acts of the partnership. Similar to a sole proprietorship, a partnership is not deemed a separate legal entity and therefore losses and profits made by the business are passed through to be reported on the partners' personal Form 1040 with Schedule E attached. In addition to the Form 1040, owners of a partnership must also file an informational form, Form 1065 to make the government aware of how much the business earned or lost that year.

Similar to a proprietorship, a partnership is legally inseparable from its owners. Therefore, partners are personally liable for business related obligations. In addition, the business actions of any one partner reflect all of the partners and all can be held personally liable for the actions of one.

The transferal of partnership interests can be very complex. Approval of the other partners may be required before partnership interests may be sold off. In most cases, a partnership is legally dissolved upon the death, retirement, insanity, resignation or expulsion of a general partner.

Following are some pros and cons of operating a business as a partnership:

  • There are no restrictions as the number or type of owners that can participate in the partnership. However, partnerships with a large number of partners can be difficult to manage.
  • A partner is not considered an employee. He is considered self-employed and is therefore responsible for paying self-employment taxes.
  • Partners may not be able to contribute as much to their pension plans as S corporation shareholders can.
  • Many complex tax accounting rules apply to partnerships.
  • Upon the sale of your interest, part or even all of the gain may be taxed at ordinary income rates.
  • Drafting a partnership agreement can be very complex and involved, yet essential to the operations of the business.
  • Converting to a C or S corporation can usually be done with no adverse tax consequences.