A business partnership is a type of business entity. It is naturally formed whenever two or more individuals create a business. Other forms of business entities are available to two or more people who want to share in the creation of a company, but they must be specifically selected and must be registered with the state. A partnership is formed when no other choice is explicitly made.
In a partnership, each partner shares in the profits and gains and any losses. Partners are permitted to contribute resources to the new business, including:
- Labor
- Property
- Assets, including money
In deciding whether a partnership has been formed, it is not relevant whether or not the individuals were attempting to create one or not. The only important factor is whether the parties intend to proceed as co-owners of a business for profit. Two factors can be examined to determine this: whether the partners will share in the profits and whether they have the right to control the business.
For example, suppose Person X and Person Y open a coffee shop. They make joint decisions about the coffee shop and split the profits. Even if they do not refer to themselves as partners, their business relationship meets the definition of a partnership.
Although it is not required, most partnerships have a partnership agreement. A partnership may either be a general partnership or a limited partnership, depending on its goals, on the type of investment each partner makes, and on which partners run the business.
Why Would Partners Dissolve a Partnership?
A partnership tends to be less permanent than other types of businesses, such as corporations. Some partnerships are only formed for a specific purpose, such as the creation of a product or the sale of a piece of real estate. Once that purpose has been fulfilled, the partnership may end.
Other reasons why a partnership may be terminated or dissolved include:
- The death or incapacitation of one of the partners
- A dispute has arisen between the partners
- One of the partners files for bankruptcy. General partnerships typically dissolve immediately if one of the partners
- cannot proceed financially.
One of the partners has retired or is planning to retire
- The partnership has grown so large that the partners wish to incorporate it to form a more permanent business entity
A partnership may also terminate according to specific terms outlined in the partnership agreement. Last, if a partnership is found to be engaging in illegal activity, the partnership will dissolve by operation of law.
What is the Difference between a General Partnership and a Limited Partnership?
In a general partnership, every partner fulfills both the roles of business manager and investor. In a limited partnership, there is at least one general partner, and there may be any number of limited partners. Limited partners are merely investors; they have no responsibility for the day-to-day operations of the business.
One of the differences between a general partnership and a limited partnership is that a general partnership dissolves immediately upon the death of a partner or if one partner becomes unable to proceed with the partnership. In a limited partnership, however, even if a limited partner withdraws from the partnership, the partnership continues because since limited partners do not share in the responsibilities or management duties of the partnership, it can proceed without them.
A partner in a general partnership may bring tort, contract, or criminal lawsuits against another partner because each partner is considered an agent of the other. The partners have a fiduciary duty to act in the best interest of the partnership. If one partner breaches their fiduciary duty, the other partner may sue them for any damages resulting from the breach.
As mentioned, a limited partnership includes at least one general partner and one or more limited partners. The general partners make management choices for the business, while limited partners do not. The general partner assumes 100% of the risk for liabilities or debts of the limited partnership. Limited partners only risk those financial contributions that they made to the partnership.
Does a Partnership Pay Taxes?
No. A partnership does not pay taxes on the income generated by the partnership. A partnership is what the Internal Revenue Service (IRS) calls a “pass-through” entity. In this type of entity, the income passes through to the partners. The individual partners then pay taxes on their share of the business income. The partners are required to report their shares of losses or profits on their tax returns. In addition, partners must also pay self-employment tax on any income they derive from the partnership.
How Does a Partnership End?
A partnership may end for several reasons, as noted above. How a partnership is officially terminated depends on the state laws governing partnerships, the type of partnership, and whether the termination is a dissociation or a dissolution.
A disassociation terminates one partner’s legal relationship with the partnership, including any right to profits and obligations for debts or other liabilities. If the partnership continues without the partner, the partners or the partnership must buy out the dissociating partner’s interest. The dissolution process occurs when the entire partnership is terminated. A dissociation, in contrast, occurs when only one partner attempts to end their association with the partnership.
Any partner may dissolve the partnership at any time by providing a notice of dissolution. The partnership is then required to wind up its business activities and distribute its assets. Winding up includes liquidating or distributing any property or assets remaining after the dissolution of the partnership.
The winding-up process can begin in one of two ways: by a partner’s petition or a creditor’s petition. A partner can petition to wind up the partnership if they do not believe it has a sustainable future. (Note: this is only permitted if no bankruptcy petitions are pending.) In addition, to recover as much of its money as possible, a creditor may petition to wind up an insolvent partnership to satisfy the debt owed to the creditor by the partnership.
During the winding-up process, only those partners that remain in the partnership have the right to any partnership assets. The winding-up procedure requires the partnership to:
- Collect any remaining business assets
- Settle any remaining debts owed to non-partner creditors
- Distribute the remaining assets to the remaining partners
Any funds resulting from the wind-up stage are first used to pay off any outstanding debts of the partnership. Any remaining funds will be distributed to the partners individually. This distribution is typically based on their ownership interest in the partnership. In addition, the partnership should notify state and federal tax authorities, creditors, and clients that the partnership is dissolving.
Should I Hire a Lawyer to Help with Winding Up a Partnership?
Yes, it is essential to hire an experienced corporate lawyer to help with ending a partnership. Dissolving or terminating a partnership will have major consequences for the business interests of the partners and the personal interests of each partner.
An attorney can provide advice on your options for dissolution or termination. Your attorney can also inform you of the partnership laws in your state and how they will apply to your case. Last, a lawyer will guide you through the dissolution process and represent you during any court proceedings, if necessary.
