The reasons why you choose to start a business with a partner (or partners) might vary, from simply sharing the heavy workload involved in running a business to balancing out the needed skill sets for your type of business. You might form a partnership based on a straight financial need, where one partner brings the necessary startup capital to the table. No matter what the reason for forming a business partnership, you should know the differences between types of partnerships, including the tax differences. And even if it’s not legally required, you should make it a point to draft a partnership agreement. There are three types of partnerships:
- A General Partnership divides profits, liability, and management duties equally among the partners. If the partnership is not equal, the percentages must be documented in the agreement. General partnerships do not pay tax on the company’s income. All profits and losses are passed through to the partners. The partnership files a tax return but does not pay taxes on the income. Partners show their portion of the profits and losses on their personal tax forms.
- A Limited Partnership allows partners to have limited liability and limited decision-making power depending on each partner’s investment percentage. All profits and losses still flow directly through to the partners, but partners don’t have to participate in the business itself. This form of partnership works well for short-term projects.
- Joint Ventures are general partnerships and can be entered into for a limited period of time or for a single project.
So what should be in your partnership agreement? Here’s what you must include:
- How the management of the company will run, such as partner job descriptions.
- The specific contributions of each partner and the responsibilities involved in that contribution, if any (there could be none if the partnership is strictly monetary with zero decision-making).
- The partner shares assigned to each partner. These shares will probably change as time goes on, so it’s important to keep the document updated.
- How profits and losses will be shared between the partners.
- The process for bringing on any new partners.
- What happens to the partners and the business if the company is dissolved? Will the business and any debts be divided? What if one partner leaves?
- An annual review date to update the agreement.
Don’t try to create your partnership agreement from scratch. Either use an online service like RocketLawyer.com or contact your attorney for help in drafting an agreement.
By Rieva Lesonsky