Overall, there are two types of partnerships: general partnerships and limited partnerships. In both types, the general partners usually manage the business of the partnership. However, various types of partnership entities have recently developed wherein limited partners are allowed to engage in business management activities.
A general partnership is any association of two or more persons (either human beings or other business entities) who carry on a business as co-owners with the expectation of making a profit. A general partnership can come into existence by operation of law, with no formal execution. Nonetheless, it is strongly recommended that the partners enter into a binding legal agreement prior to commencing any business activities. A partnership is always a general partnership unless the owners comply with the special requirements for establishing a limited partnership. A general partnership faces the same advantages and disadvantages as a sole proprietorship, with the primary disadvantage being liability exposure for all general partners.
A limited partnership can only be created by the partners’ execution of a written agreement and the filing of a certificate of limited partnership with the Secretary of State. There are two types of partners in a limited partnership: one (or more) general partner(s) who are each liable for the debts of the partnership and one (or more) limited partner(s) who are liable to the partnership up to the amount of money they have contributed to the business. Partnerships must obtain a federal tax identification number, or FEIN. This number is used in place of a personal social security number for tax and identification purposes. Taxes are treated similar to the sole proprietorship. A partnership must file an annual income tax return; however, any amount owed is “passed through” to each partner’s personal tax return by way of an IRS form K-1.
Generally, the advantages of forming a partnership over other types of entities are lower formation costs, relative ease of partnership setup, and simplicity of management. Like a sole proprietorship, however, the greatest disadvantage of partnerships is the lack of insulation from personal liability in most instances. Experienced attorneys and tax consultants can provide solid advice as to the best use of a partnership arrangement.