In our continuing series on the various tax structures business owners can choose from in this post we will look at the three main types of partnerships and the pros and cons of each.
What is a General Partnership?
A General Partnership is an entity formed by two or more individuals to conduct business or trade. Each partner brings to the table, capitol, labor, skill sets and expertise and each partner shares in both profits and losses associated with the business. Each partner is liable for the business related actions of themselves and the other partners. Income and losses from the partnership must be reported on each partner’s personal income tax return.
Pros of a General Partnership
Simple to set up - A General Partnership does not require a state filing. The Partnership is created when the two entities begin to do business.
Inexpensive to create - While the business entity must obtain any licenses or permits required for the type of business being conducted, under a General Partnership there is no state formation filing hence no formation fee nor ongoing additional state fees or franchise taxes.
Few organizational requirements - It is advisable for individuals entering into General Partnership to create a framework for how the partnership will be managed and dissolved, but unlike a corporation it is not required. Under a General Partnership there are no annual meeting requirements or issuance of partner interests.
Tax Benefits - Profit and loss sharing by partners may decrease each individuals annual tax burden.
Cons of a General Partnership
Financial Liability- All the partners are personally liable for company debts. All the partner’s personal assets can be seized to pay company debts or satisfy judgments resulting from litigation against the company. All partners are liable for the actions of one another in the course of doing business.
What is a Limited Partnership?
Limited Partnership requires only one individual to act as a General Partner and allows one or more individuals to be Limited Partners. Under this structure at least one General Partner has unlimited liability and the Limited Partners are usually liable only for the amount invested in the business, however this varies by jurisdiction. Limited Partners typically are not involved in the day-to-day management and operation of the business and function much like a silent partner. Limited Partnership structures are beneficial to transient and short-term projects like film production, real estate transactions and estate tax filings.
Pros of a Limited Partnership
Access to Capitol - The General Partner(s) can generate capitol by bringing in additional Limited Partners.
Retention of Control - Limited Partners are not decision makers, they do not vote or have any authority in the operations or dealings of the business. Limited Partners can be replaced without dissolving the partnership.
Personal Asset Protection - Limited Partner’s liability is limited to the registered amount invested in the business.
Pass Through Taxation- Limited Partnership’s must file a tax return showing the firms profits, losses, and payments to investors. However, the actual tax burden is not paid by the Limited Partnership but is “passed through” to the General Partner(s) personal income tax burden.
Cons of a Limited Partnership
Set-up Requirements - Because Limited Partners are essentially investors Limited Partnerships must adhere to the compliancy standards of their jurisdiction. The entity must create a Partnership Agreement in the county where they do business and they must hold annual meetings.
Liability for General Partners - There is a greater risk to General Partners because they are personally liable for all debts and taxes associated with the firm. Their personal assets can be seized to satisfy debts. If the company goes into bankruptcy or is sued the General Partners are wholly liable.
What is a Limited Liability Partnership?
A Limited Liability Partnership is basically the same as a General Partnership except partners have the benefit of some personal liability protection. Typically a partner is only liable for his or her negligence or malpractice and or the actions of employees under their direct supervision.
Pros of a Limited Liability Partnership
Paperwork and Formal Requirements- Like the other partnership structures a Limited Liability Partnership has fewer restrictions and annual requirements than a corporation.
Flexible Framework - Partners have more flexibility in determining which partners are responsible for each aspect of the day-to-day management and operations of the firm.
Pass Through Taxation - Like General and Limited a Limited Liability Partnership’s tax burden is passed through to the General Partners tax liability and profits and losses are reported on the General Partners individual income tax return.
Simple Conversion - A Limited Liability Partnership is typically easier to convert to from a General Partnership than to a Limited Liability Company or Corporation.
Partnership Protection - Limited Liability Partners are generally not personally liable for company debts.
Cons of a Limited Liability Partnership
Set-up and Fees - Limited Liability Partnerships must pay a state fee based on how many partners are invested in the firm. In some states Limited Partnerships are only available to certain types of businesses like Accounting and Law firms.
Liability for Limited Partners - Limited Partners are liable for their actions and the actions of employees under their supervision. If a Limited Liability Partner engages in the day-to-day operations and management of the company, they can loose their limited liability protection and in a sense become a General Partner.
Regardless of which type of business entity you choose it is advisable for new business owners and entrepreneurs to get professional advice on how best to move forward in setting up shop. Tom Bulger, CPA can help you determine which tax structure is right for your new venture and the best way to move through the process. Tom Bulger has been helping to create successful small businesses for over 25 years. Give Tom Bulger a call today.