Partnership: The Pros and Cons

When starting or operating a business, one of the decisions that you have to make is to choose a form of business entity.

Last week, we have already discussed the most common form, which is a sole proprietorship.

The next form of business operation is a partnership.

A partnership is formed when two or more people form an agreement to carry on a business for a profit. Forming a partnership is very similar to forming a sole proprietorship as far as the ease of  formation is concerned but it just comprised of more than one person.

Partners co-own the business and share control over the operations and the right to share profits. There should be a legal agreement among partners that identifies how much time and capital each will contribute, how decisions will be made, how profits will be shared,  how disputes will be resolved,  how future partners will be admitted to the partnership, how partners can be bought out, and what steps will be taken to dissolve the partnership when needed.

One thing people said about partnership is that it is like a marriage but without the sex.

What are the Advantages?

  • Ease of Formation – When it comes to ease of formation, partnerships is next to sole proprietorship. There are no entity documents that need to be filed with the state that are normally occurs with LLC and corporations.
  • Raising of Capital – Can raise more capital better than a sole proprietorship due to multiple resources or owners.
  • No double Taxation – The business is not a separate legal entity. Thus, there are no double taxation and the profits “passes through” directly to the partners’ personal tax returns.
  • Complementary Partner’s Skills – The business benefits from complementary skills of the partners. For example, for someone who’s running a restaurant, one person may be good with cooking while the other partner may be good in managing the business operations.
  • Incentives to be Partners – Prospective employees may be attracted to the business if given the incentive to become a partner. For most service businesses such as accounting, lawyers or doctors, this may be a good incentive to attract and keep your best employees.

What are the Disadvantages?

  • Unlimited liability – Individual partners have unlimited liability. Partners are jointly and individually liable for the actions of the other partners. So if your partner obtains debt for the business, then you may be liable for that debt as well.
  • Disagreements – Each partner does not have complete control and potential disagreement normally occurs
  • Shared Profits – Unlike the sole proprietor where the owner receives all the profits, profits must be shared with other partners in a partnership.
  • Continuity – The partnership may have a limited life since it may end when one of the partners dies or withdraws.

Is a Partnership Right for You?

A partnership may be right for you if:

  • You want to start a business and you want to have a person with a complementary talent or skill that you do not possess but needed for your business. For example, you want to run an accounting firm but you only know taxes but your partner knows business management and auditing.
  • You need additional funding for your business. For example, you need to start a business but you’re short on start-up capital and you can no longer find any sources of funding except through forming a partnership.
  • You do not want to be taxed twice on the profits of the business.  Corporate profits are taxed twice: when earned by the business and taxed again when distributed to the shareholders.

Most Common Federal Tax Forms for Partnerships

  • Form 1065: Partnership Return of Income
  • Form 1065 K-1: Partner’s Share of Income, Credit, Deductions
  • Form 1040: Individual Income Tax Return
  • Schedule E: Supplemental Income and Loss
  • Schedule SE: Self-Employment Tax
  • Form 1040-ES: Estimated Tax for Individuals