This is an excerpt from a presentation I give to college students and to prospective entrepreneurs about types of business entities.
A college professor (who’s also an attorney) told me that my presentation on this subject is the best, clearest and most-concise overview of the topic that she’s ever seen.
I’m flattered by the compliment, and will try to translate those positives into a series of blog posts.
We turn now to partnerships. A partnership exists whenever two or more people come together to conduct business and share in the profits of the business.
A partnership can exist — for both tax and legal purposes — even if there’s no written agreement in place.
All tax pros and attorneys will tell you that there should be a written agreement in place. But a partnership can exist without one.
Partnerships themselves do not pay income taxes. Instead, partnerships file an information return called Form 1065.
The end results of partnership operations (such as net income) are divided among the partners based on the partnership agreement. The partners then report their share of partnership operations on their personal tax returns.
Advantages of a Partnership
- They provide a way to pool resources. Two or more people can come together and pool money, equipment and knowledge — something that really can’t happen in a sole proprietorship.
- They can have different classes of partners. This can be useful if you’re seeking investors but don’t want to be a corporation. You can have general partners and limited partners. General partners are partners who are involved in the day-to-day operations of the partnership; they owe self-employment taxes on their share of partnership net income. Limited partners are not involved in the day-to-day operations of the partnership and generally don’t owe self-employment tax on their share of partnership net income.
- Partners can generally withdraw money and property from the partnership tax-free.
Disadvantages of a Partnership
- Partners usually owe self-employment taxes on their share of partnership net income. (Limited partners don’t; general partners usually do.)
- Partners are taxed on their share of the partnership’s net income even if the partner took no money out of the partnership during the year.
- Administrative burdens. A separate tax return needs filed. There’s also a need to track basis. What is basis? I’ll explain in the next post in the series.