In the U.S., a partnership is a type of unincorporated business with two or more partners who share ownership and liability of the business. The partners share profits and losses equally or as agreed upon in the partnership agreement.
Unlike corporations, partnerships do not have the same level of formalities and are not considered separate legal entities from their owners. Instead, the partners themselves are personally responsible for the debts and obligations of the business.
The business does not pay income taxes because there is no legal distinction between it and its owner(s). Instead, all income from partnerships passes through directly onto their individual tax returns, where they will be taxed according to their respective incomes.
Types of Partnerships
The most common types of partnerships are General Partnerships and Limited Partnerships.
In a General Partnership, all partners have an equal share in the profits and losses of the business and are also personally responsible for the business debts and obligations. Each partner has the right to make decisions and manage the business operations.
A Limited Partnership is similar to a General Partnership, but it has one or more limited partners who do not have as much control over the business operations. In exchange for the limited agency, these partners are also subjected to reduced liability or no liability at all.
Taxation of Partnerships
Partnerships are taxed as pass-through entities, meaning that the business itself does not pay taxes, but the partners report their share of profits and losses on their individual tax returns. This is known as “pass-through taxation.”
Each partner’s share of the partnership’s income, deductions, and credits is based on the partnership agreement or the terms of the partnership. The partner will report this information on their individual tax return, along with their share of any other partnership items.
The partners pay personal income tax on their share of partnership income, and the tax owed is calculated based on their individual tax bracket. This means that if one partner is in a higher tax bracket than the others, they will pay a higher percentage of the total tax owed on the partnership’s income.
Advantages of Partnerships
Easy to Form. Partnerships are relatively easy to form compared to other business structures, and there is typically less documentation required to set up the business.
Shared Liability. Partnerships provide a shared responsibility for the debts and obligations of the business, reducing the risk for each partner.
Tax advantages. Partnerships can offer tax advantages over corporations as dividend taxes are applied only once – as opposed to the C corps double taxation model.
Disadvantages of Partnerships
Unlimited Liability. Partners are personally responsible for the debts and obligations of the business, which can put their personal assets at risk.
Lack of Privacy. Partners’ personal financial information and business operations are disclosed to the public, which can be a drawback for some individuals. Under some circumstances, this drawback can be circumvented by being an anonymous partner. These partners exchange control over the business for the anonymity and protection of their personal assets.
Management Issues. In a General Partnership, all partners have equal control over the business operations, which can lead to disagreements and management issues.