What is a Partnership
A partnership is a formal arrangement in which two or more parties cooperate to manage and operate a business. Various partnership arrangements are possible in which all partners might share liabilities and profits equally or some partners may have limited liability. Not every partner is necessarily involved in the management and day-to-day operations of the venture, such as in the case of a "silent partner." In some jurisdictions, partnerships enjoy favorable tax treatment relative to corporations.
BREAKING DOWN Partnership
In a broad sense, a partnership is any cooperative endeavor undertaken by multiple parties. These parties can be governments, non-profits, businesses, individuals or a combination, and the goals of the partnership can vary widely. There may or may not be a written agreement governing the partnership, but it is generally a good idea to specify terms at the outset so that disagreements can be settled according to predetermined rules. In some cases such an agreement is legally required.
Within the more narrow sense of a for-profit venture undertaken by two or more individuals, there are three main categories of partnership. In a general partnership (GP), all parties share the legal and financial liability of the partnership equally. In other words, the individuals are personally responsible for the debts the partnership takes on. Profits are also shared equally, in principle, but the specifics of profit sharing will almost certainly be laid out in a partnership agreement.
Limited liability partnerships (LLP) are a common structure for professional firms, such as accounting, law and architecture firms. This arrangement limits partners' personal liability, so that, for example, if one partner is sued for malpractice, other partners' individual assets are not at risk as a result. Some law and accounting firms make a distinction between equity partners and salaried partners, who are more senior than associates but do not have an ownership stake in the partnership. They are generally paid bonuses based on the firm's profits, but this is not required or guaranteed.
Limited partnerships (LP) 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, while at least one partner's liability must be limited to the amount she's invested in the partnership. Sometimes referred to as a silent partner, this partner generally cannot participate in the management or day-to-day operation of the partnership; she must have a limited role to enjoy limited liability.
Finally, limited liability limited partnerships (LLLP) are new and relatively uncommon. LLLPs are limited partnerships that provide a greater shield from liability for general partners.
Partnership Legal Treatment
The basic arrangements described above (with the exception of LLLPs) are widespread in common law jurisdictions such as the United States, Britain and the Commonwealth. There are, however, differences between the laws in these jurisdictions, and individuals looking to found a partnership should seek professional legal advice. In the U.S., each state has its own laws governing partnerships. There is no federal statute that defines the various forms of partnership, but a majority of states has adopted one form or another of the Uniform Partnership Act, which has undergone a number of revisions between 1914 and 1997.
The standard version of the Act defines the partnership as a separate legal entity from its partners, which is a departure from previous legal treatment of partnerships. This issue has not been finalized, and not all states have adopted this language. Other common law jurisdictions, such as England and Wales, do not consider partnerships to be independent legal entities.
Partnership Tax Treatment
While there is no federal statute defining partnerships in the U.S., the Internal Revenue Code (Chapter 1, Subchapter K) includes detailed rules on federal tax treatment. Partnerships do not pay income tax; it passes through to the partners. Partners are not considered employees for tax purposes. Individuals in partnerships may receive more favorable tax treatment than if they had founded a corporation; corporate profits are taxed, as are the dividends paid to owners. Partnerships' profits, on the other hand, are not double taxed in this way.