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The General Partnership, Rules and Taxations

August 7, 2009

A general partnership  is an association of two or more people carrying on a business with the goal of earning a profit.

A partnership is viewed as being one and the same as its owners. There is little formality involved in creating a partnership. In fact, if someone can establish that you are in business with somebody else, then there is a general partnership. The intention or lack thereof of having a formal partnership is not important.

Existence of a Partnership

Rules for determining the existence of a partnership are outlined in Part II of the Uniform Partnership Act (UPA). Some of these rules are summarized as follows:

1.  Joint tenancy, common property, part ownership, etc. does not by itself establish a partnership, regardless of whether the owners of the property share any profits from it. Three ways to jointly own property are:

A.     Tenants in common – when one dies, one’s portion of the partnership are transferred to one’s heirs.

B.     Joint tenancy – right of survivorship – when one dies, the entire interest goes to the other person.

C.     Tenancy by entirety – for example, a husband and wife. Each tenant owns by whole and by part. If a third party has a claim against the husband, the claimant cannot go after the property since it belongs wholly to the wife as well. For this reason, banks often require both the husband and the wife to sign a loan.

2.  Sharing of gross returns from jointly held property also does not by itself establish a partnership.

3.  The receipt of a share of profits from a business is evidence of being a partner of that business, unless the profits were received as payment on a debt, interest, wages, rent, etc.

A person may be considered a partner even if not formally included in the partnership. This is known as partnership by estoppels. “Estoppels” means that one is not permitted to deny. In the context of partnerships, it means that a person cannot deny being a partner if he permits the partnership use his name. Take for example, a situation in which partner A and partner B start a business and offer non-partner C a profit interest in the company if they can use C’s name in the business. If a bank lends money to the partnership and the partnership becomes insolvent, C would be considered a partner and could be held liable.

Partnership Taxation

Like a sole proprietorship, a partnership has only one level of taxation. A partnership is a tax-reporting entity, not a tax-paying entity. Profits pass through to the owners and are divided in accordance with what is specified in the partnership agreement. There are no restrictions on how profits are allocated among partners as long as there is economic reason, so there is latitude in allocating income according to which partners have the best tax rates.

Liability

While pass-through taxation is an advantage, owners of a partnership have unlimited personal liability. In general, each partner in a partnership is jointly liable for the partnership’s obligations. Joint liability means that the partners can be sued as a group. Several liability means that the partners are individually liable. In some states, each partner is both jointly and severally liable for the damages resulting from the wrongdoing of other partners, and for the debts and obligations of the partnership.

Three rules for liability in a partnership are:

  1. Every partner is liable for his or her own actions.
  2. Every partner is liable for the actions of the other partners.
  3. Every partner is liable for the actions of the employees of the business.

Risk and Control

Absent an agreement to the contrary, UPA gives partners equal voting rights, even if they contributed different amounts of capital. Squeeze-outs are a common issue in partnerships.

Expense and formality

As in the case of a sole proprietorship, if the partnership chooses a fictitious name (different from the names of the partners), it is required to file that name with the state.

Fiduciary Duty in a Partnership

Partners both a contractual duty and a fiduciary duty to one another. According to Black’s Law Dictionary, a fiduciary duty is the duty to act for someone else’s benefit while subordinating one’s personal interests to those of the other person. These days however, many operating agreements waive the fiduciary duty so that one can pursue other opportunities that may come along.

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