What is a Partnership?
A partnership is an incorporated business entity where multiple owners contribute their time, labor, property, or money before sharing in the company’s profits and losses.
It’s one of the most common legal structures in the country — largely due to the ease with which one can launch and register a business.
Forming partnerships can take different routes. Some partners may have limited liability while others may be silent and not be involved in daily business activities.
Before forming a partnership, you will need an Employer Identification Number (EIN). Easily file for an EIN with GovDocFiling.
Types of Partnerships
Partnership contracts can be express or implied; meaning that the agreement can be put on paper or inferred through conduct. They can also be between individuals, businesses, or non-profit organizations.
There are four main types of partnerships:
General partnership
General partners share both profits and losses equally and are personally responsible for liabilities if any. The terms of such partnerships are outlined in the partnership agreement.
Limited partnership (LP)
This partnership has both silent and active partners. The active business partner takes full responsibility for the business’s debts while the other is a limited partner; ie their liability is restricted by their contributions.
Limited liability partnership
(LLP)
These are common for professional businesses, and they limit partners from the personal liability of other partners. i.e. if one partner gets sued for malpractice, other partners are not personally liable.
Limited liability limited partnership (LLLP)
It’s a new type of partnership that works just like the limited partnership does. However, all partners are limited partners. They have personal liability protection from the business’s losses and litigations if any.
When forming a partnership agreement, you should also include dismissal terms mentioning grounds for a partner’s exclusion from the business.
What Are the Advantages of Forming a Partnership?
Forming a partnership comes with many advantages. Here are the main ones.
| Easy to Form | Partnerships can be created either formally or verbally. The only formal documentation needed is the partnership agreement, which is also optional. Filing for taxation is quite simple too. |
| Shared Responsibility | Unlike in a sole proprietorship, you’ll share the burden of running the business together with your partners. They also bring with them skills and contacts giving your business a better chance of success. |
| More Control | Unlike in corporations, there’s minimal interference in the decision-making process of partnerships. As long as the partners agree, they can manage their affairs smoothly. |
| Privacy | When forming partnerships, the business has no obligation to share any of their documents with the public. They can keep their business affairs confidential, unlike public limited corporations. |
| Profit Sharing | Partners can easily share the profits from their businesses. This is unlike in limited companies where profits are retained and paid out either as salaries or dividends to shareholders. |
| Fewer Legal Obligations | Partnerships are relatively affordable to maintain. Instead of having to file both personal and corporate taxes, every partner in the business reports profits and losses as individuals. |
| No Double Taxation | Partnerships have pass through taxation. They can avoid the “double taxation” that most corporate owners have to pay. This also simplifies tax prep since you only need to report profits and losses once. |
In fact, there are no additional federal filing requirements when forming a partnership — except for the Employer Identification Number (EIN).
Disadvantages of Partnerships
While there are lots of advantages to forming a partnership, it also comes with some shortcomings. These include:
Not Being a Separate Legal Entity
A partnership is not a legal entity separate from its owners. Therefore, unless there are any alternative agreements in place, a partnership will be dissolved when a partner dies or resigns.
This could make the business unstable and divert the partners’ attention toward developing the business. Sometimes, even with a partnership agreement, the partnership may still get dissolved if it can’t buy the leaving partner’s share of the business
Unlimited Liability for Partners
Since the business is not a separate legal entity, partners aren’t protected from personal liability. In case the business incurs any debts or losses or encounters legal problems, the partners’ assets may be at risk.
Partners can sometimes be jointly or separately liable, depending on the type of partnership you’re in. Sometimes, one partner’s liability can affect other partners, e.g. if they’re unable to pay a debt, other partners may end up taking up part of the responsibility.
Limited Access to Capital
Partnerships give you a chance to raise more capital than sole proprietorships. However, public corporations and LLCs give you a better chance at raising capital than all other business forms, given their formal structures.
Limited liability companies and corporations have a more transparent structure and are separate legal entities. Public corporations also have financial transparency unlike partnerships, and this makes it less risky for banks and lenders to give loans.
Choosing a Partner
Forming a partnership business, running it, and maintaining it can be a difficult task given the dynamics of shared responsibility and authority. Therefore, one of the many crucial decisions you need to make as a business owner before forming a partnership is choosing the right partners.
Here are factors you need to consider before bringing them on.
Personal Assets: If your partners own less than you in personal assets, you may have to give up more in the event that your company incurs a huge debt.
Personality: You’ll need to have an understanding with your partners so you can resolve disputes, and make better decisions for your business.
Business Goals: You’ll need to know if your partners share the same vision for your business as you or if they’re just looking for income.
Responsibilities: When choosing your partners, you’ll need to know how much time they contribute to the business and how reliable they are.
Roles: You’ll need to outline which roles you intend individual partners to take up in the business. The roles need to be aligned with each partner’s skills.
A partner should contribute to the business both in assets and expertise.
Rights and Responsibilities of Partners
The general rights and responsibilities that come with forming a partnership are outlined in the Uniform Partnerships Act. The partnership agreement may alter some of these, with the exception, typically, of laws governing the partners’ interactions with third parties.
Partner Rights
Some general partner rights include:
- Partners who contribute to the business financially ought to be repaid with interest.
- Partners have equal access and rights to property held in the name of the business.
- Partners have an equal share in profits and losses unless stated otherwise.
- All partners have equal say in the management and business decision-making.
- All partners can access the business’s accounting records and financial activities.
- Addition of new partners must be consented to by all the partners.
Partner Responsibilities
The responsibilities include:
- Income received from the partnership’s assets must be disclosed and paid back.
- Each partner must dedicate their skills, time, and effort to grow the partnership.
- A majority vote must be obtained to settle any disagreements.
- It is forbidden for partners to run a business that competes with the partnership.
- Any assets a partner obtains for the partnership must be given to the partnership.
What is a Partnership EIN?
Also known as a Tax ID, an Employer Identification Number allows a new business to do everything from opening a new bank account to taking out loans to hiring employees.
It’s a nine-digit number issued by the IRS to help identify businesses when filing their taxes. Not all businesses require this unique number, for instance, a sole proprietor and a single-member Limited Liability Company only need their social security number unless they plan on hiring employees.
When forming partnerships, you’ll need an Employer Identification Number since they structurally have over one owner and will need to submit their tax documentation separately.
Why You Need a Partnership EIN?
Although it’s technically possible to use your Social Security number instead of an EIN, this exposes you to a much higher risk of identity theft. Using personal information can also make your new business look less professional.
This is why you need a separate EIN when forming a business partnership. Other benefits include:
Opening a Bank Account
Use your partnership EIN to open a separate business bank account.
Opening a Bank Account
Borrow money through the business and don’t personally guarantee the loan.
Additional Privacy
You will not need to use your social security number for tax purposes.
Easy Hiring
You can hire independent contractors and provide them with a 1099 form.
In addition, many suppliers, vendors, and clients will need your partnership Employer Identification Number to reconcile their taxes and filings.
How to Obtain an EIN When Forming a Partnership?
You can apply for an EIN with the IRS via mail, fax, in-person, or online. Through fax, you’ll get a response within a week and it could take up to four weeks by mail to have your application approved by the IRS.
Here’s some information you’ll need:
Personal details of the partners
Date the business began or will begin operating
Name and address of the company
Contact information of the employees
Applying for a partnership EIN online is the simplest and fastest way to obtain a tax ID for your business. GovDocFiling can expedite the process and make it simpler for you.
How To Form a Partnership Legally?
Forming a partnership can either be done expressly or it can be implied. Implied business partnerships are easy and do not need as much documentation or formal procedure.
Conversely, an express partnership entails structure, and forming such partnerships can be done through a legal contract or sometimes a verbal agreement.
Forming an Implied Partnership
Implied partnerships happen when two or more people carry out a business together for profit, without necessarily intending it as a partnership.
The problem is how informal they can be. With a lack of structure, the partnership becomes a word that can define different forms of business relationships. That’s why there are legal tests to determine if an implied partnership has been formed.
Testing the Existence of an Implied Partnership
There are innumerable circumstances that can lead two or more people into co-owning a business. How do you then test the existence of an implied partnership?
Based on the definition of partnerships, here are elements to guide you:
| Association of Persons | The people or parties forming or carrying out a business together need to have the capacity to enter into contracts. This can include individuals, government agencies, corporations, etc. |
| Co-Ownership of a Business | The asset being owned needs to be a business, i.e. an entity with assets, income, employees, profits, debts, etc. The same applies if they own a profit-making property. |
| Profit Motive Business | The business needs to be a for-profit business to qualify as a partnership. Unincorporated non-profit organizations do not qualify as partnerships for this reason. |
| Sharing of Profits | The co-owners also need to share the proceeds from their business dealings amongst themselves. This is unless the profits were shared as compensation for wages, debt, interest, etc. |
| Other Factors | Besides co-ownership and profit sharing, other factors such as decision-making and liability sharing are also considered by the law when testing implied partnerships. |
Forming an Express Partnership
Here are steps to follow when forming an express partnership:
Choose Partners and Determine Type of Partnership
Choosing the people you’ll work with should be the first step towards forming a partnership. You’ll need their skills, knowledge, credibility, and financial contributions.
Part of this also involves outlining and understanding your business’s goals and vision. Some items to consider include:
- What you want to bring to the business, what the partners can contribute, and what you all want to get out of it.
- Are there any family members that you would like to involve in your business and how often that would be?
- Whether you’re looking to have a steady income from the partnership or if you want a tax shelter.
- How you will handle your finances, profits, and accounting, and what role other partners will play.
Then, you can choose the structure you want when forming your partnership. Here, you’ll need to first check with your state law to see which partnerships are legally available.
Choose a Name for Your Partnership
The next step would be to pick a suitable business name for your partnership. Most general partnerships have names that are a combination of the partners’ last names.
Here are some considerations to keep in mind while choosing a name for your partnership.
- Check availability: You’ll need to check with your secretary of state to make sure the business name you choose isn’t taken by any other company.
- Check partner name regulations: Some states may have laws regarding the use of partner names in your business name. You’ll need to check this as well.
- Corporate designation laws: Check if your state has any laws for including corporate designators in your business names, such as LP to show business type.
- Check domains: Ensure there isn’t already a website domain with your business’s name that may cause confusion when you finally launch a website.
Make sure you consider all these before you fill out any paperwork for forming a partnership.
Create a Partnership Agreement
While forming partnerships does not need legal guidelines, a partnership agreement is important. This is a legal document that states how your partnership will be run, ensuring order between partners.
Here are some items a partnership agreement may contain:
- Partner information: This includes names, contact information, and types of partners e.g. general partner, and so forth.
- Partner contribution: Includes a partner’s capital contribution, knowledge contribution, and share of ownership.
- Partner distribution: This entails how responsibility is shared among the partners and their profit-and-loss distribution guidelines.
- Conflict resolution: Outlines a procedure for settling disagreements or any other tie-breakers e.g. if voting is involved in decision-making.
- Partnership dissolution: Includes terms and guidelines for dissolving the partnership, how to distribute funds, etc.
A partnership agreement is a legally binding document that acts similarly to the articles of incorporation for corporations.
Determine Tax Obligations and Apply for an EIN
The Internal Revenue Service requires every business to pay taxes regularly. As a co-owner, you’ll want to ensure that you know your tax obligations and are compliant.
For this, you’ll need an Employee Identification Number. Here are some tax obligations for partnerships:
- Partnerships are required to fill out the US return of partnership income form 1065 to report their gains, income, losses, credits, etc.
- Each partner is also required to complete their individual tax return using Schedule K-1 of the same form (1065).
- The company will be responsible for reporting other taxes for example, sales tax, if any, on behalf of the partners.
- Depending on your state, you may need other tax documents such as federal tax ID, local tax ID, business tax ID, to report relevant taxes.
You’ll need to consult your state, local government, and the Internal Revenue Service to know which Tax ID numbers, business licenses or permits you’ll need to get.
Register Your Partnership
If your partnership is a limited partnership, limited liability partnership, or a limited liability limited partnership, you’ll need to register your partnership with your state.
Here’s what you need to do:
- Choose a state to register your business. The best option is your home state or the state where you’ll conduct the bulk of your business.
- Check all your state’s licensing requirements and apply for all the required licenses and permits for your business.
- Apply for your chosen structure by filling out relevant forms and sending them to the secretary of state or the county clerk’s office.
- Appoint a registered agent for your partnership, one with a physical address in your state, who is available during business hours.
- Submit your application online or via mail to your secretary of state and pay all the relevant fees involved.
Further, you’ll need to look out for any additional reports you may need to file in the future e.g. any annual reports etc.
Select an Accounting Option
You’ll need a separate bank account for your business to avoid mixing your business and personal finances. With that, you’ll need to track your finances accurately.
As such, choosing a good accounting solution is a crucial decision for your business. Here are points to consider.
- Manual accounting can get time-consuming, tedious, and prone to mistakes as the business grows.
- Hiring a professional bookkeeper will help keep your financial records accurate but can get expensive.
- Using DIY accounting software is affordable but comes with a learning curve and can be time-consuming as well.
- Hiring a professional and providing them with suitable accounting software is the most accurate, as well as the most expensive option.
Each option has its advantages and disadvantages at every stage of the business.
Therefore, depending on your business needs and budget, you can find an effective accounting option that saves time and streamlines all your accounting processes.
Why Should You Partner With GovDocFiling?
Of all the corporate structures out there, partnerships are some of the easiest to form. That said, the process isn’t necessarily “easy.”
Many entrepreneurs struggle with the first step — applying for a partnership Tax ID number. That’s because dealing with the Internal Revenue Service often involves lots of paperwork, hassles, and delays.
That’s where we can help. Here’s how.
| Quick and Simple | GovDocFiling’s simplified process helps get your business up and running as quickly as possible. |
| Great Customer Support | Once your partnership EIN is approved, you can still access a range of resources and customer support options. |
| Expedited Process | Rather than fill out tons of paperwork and wait for lengthy approvals, you can use our intuitive one-page application. |
Frequently Asked Questions
Some considerations when forming a partnership are:
- Choosing your partners and the type of partnership
- Naming your partnership business
- Drafting a partnership agreement
- Knowing your tax obligations and getting an EIN
- Registering your partnership with the state
- Getting other relevant licenses and permits
All partnerships are required by US law to submit Form 1065 to the IRS every year if there was any income earned.
If your business has not made an income that taxable in your first years, then you won’t need to file federal returns.
Registering partnerships is optional, and the partners get to decide whether to register their business.
The penalty for not filing tax returns on time is 20% of the tax charged.
Ready to Form Your Partnership Today?
Running a successful business requires overcoming any number of challenges. However, registering your partnership EIN shouldn’t be one of them.
Discover how easy and intuitive launching a business can be with our simplified filing process.