A general partnership is created when two or more people engage in business as co-owners for a profit. A general partnership is created automatically as a matter of business law without filing any paperwork with the State, however, in California the partners may choose to file a Statement of Partnership Authority (Form GP-1) with the Secretary of State.
Below is a discussion of the characteristics of a general partnership based on the factors to consider when choosing a business entity.
Personal Liability (Unlimited Liability)
One of the major downsides of operating a business as a partnership is that there is no limitation on liability. Each partner is personally liable for the acts of the other partners done in the ordinary course of business and for any liabilities of the partnership as a whole. For example, Peter Partner and Pepper Partner conduct business as a partnership doing landscaping work (Peter Pepper Pruning). Under a contract with the business, Peter is mowing the lawn of a customer’s house and accidentally knocks over and breaks an expensive statue. The customer wins a lawsuit against Peter as an individual. In this scenario, because there is no limitation on liability, the customer is able to recover assets from Peter and from Pepper. If Peter Pepper Pruning had limited liability (through the creation of an LLC, for example), then Pepper’s assets would not be on the table to the customer.
Tax Treatment of General Partnership
In a general partnership, there is no entity level tax. Rather, the profits and losses are passed through to the individual partners and are reported on the individual’s tax returns. Although the partnership itself does not pay income tax, it is still required to file an informational return on Form 1065 with the IRS. The business also must issue a Schedule K-1 to each partner to report the pass through profits and losses from the partnership on their individual returns. The pass through treatment of partnerships is generally considered one of the most appealing characteristics of a general partnership. However, pass through taxation is available to other entities as well, such as LLCs and S-Corporations (both of which enjoy limited liability as well). Additionally, in certain situations, owners of businesses taxed as S-Corporations can avoid self-employment taxes on a portion of the money they receive from the business as profits. This tax benefit is not available to general partnerships.
Sources of Funding
As with sole proprietorships, the general partnership is basically indistinguishable from the individual owners, so the only sources of funding that are available to general partnerships are the sources generally available to individuals. So while you may be able to get a loan for the business, you can’t raise any equity funding by giving up an ownership interest in your business.
In California, you are not required to file any paperwork with the State or elsewhere to create a general partnership (although you can choose to do so). If you do business under a trade name, then you must file a fictitious business name statement in the county where your principal place of business is located. Additionally, there are virtually no formalities associated with governance or other requirements for general partnerships.
One big disadvantage of a partnership is that it is not perpetual in nature (unlike LLCs or corporations) and it can be dissolved easily, and often against the will of one or more of the partners. For example, in a partnership at will, a partnership is dissolved when a majority of the partners express their will to dissociate from the partnership.
Although it is not required, it is a good idea to create a partnership agreement among the partners to clarify each partner’s roles and responsibilities. So even though Peter Partner and Pepper Partner are brother and sister (and best buds), it is a good idea for them to create a partnership agreement to set expectations and be clear on how things will work in the business.
Contact us to discuss whether a partnership will be a good fit for your goals.
DISCLAIMER: The information in this article is provided for informational purposes only and should not be construed or relied upon as legal advice. This article may constitute attorney advertising under applicable state laws.