Organizing Or Cleaning Up a Partnership

Vol. 1, No. 6

Jean L. Batman founded Legal Venture Counsel, Inc. in 2004 to provide outside general counsel services to investors, entrepreneurs, and small businesses. Prior to forming Legal Venture Counsel, Ms. Batman was a Partner in the San Francisco offices of Duane Morris LLP, one of the country’s 100 largest law firms. As outside general counsel to a variety of companies and individuals, Ms. Batman provides business and financial legal services to privately held entities operating in a broad range of industries including real estate development, financial and professional services, manufacturing, software, retail, biotechnology/specialty pharmaceutical, and high technology.

 

From Advising the Small Business

 

  • Find out what the different partnership structures are.
  • Learn what roles partners play.
  • Discover what the obligations of a partnership entail.

 

What Are the Basic Partnership Types and Structures?

The two primary types of partnerships are the following, although other variations have been created by statute and may vary by state:

 

1. General Partnerships

General partnerships, like sole proprietorships, are often formed by default. When two or more people enter into a business venture together without forming a legal entity, they create a general partnership. General partnerships are not particularly desirable as a form of doing business, because all of the partners are vulnerable to being held personally liable for the obligations and liabilities of the business. In the absence of a partnership agreement providing for the manner in which profits and losses are to be shared, profits in a general partnership are shared equally among the partners. For the specific provisions governing general partnerships in your state, see your state’s Revised Uniform Partnership Act (RUPA) and the partnership agreement, if any.

 

2. Limited Partnerships

Limited partnerships are traditionally comprised of two or more persons, with at least one designated as the general partner and at least one limited partner. The general partner has unlimited liability for the obligations of the business, while the limited partners are entitled to limited liability (similar to a shareholder in a corporation or a member in an LLC). Limited partnerships are established pursuant to statutory requirements, and they are formed by the filing of a statement with the secretary of state. To maintain their limited liability status, limited partners must be passive; that is, they may not participate in the management of the company. General partners are typically entities that offer their owners limited liability, rather than individuals, so no individual is subjected to unlimited liability. Limited partnerships are governed by their limited partnership agreements and the provisions of the Uniform Limited Partnership Act adopted in their state of formation.

 

What Are the Roles of Partners?

 

1. General Partnerships

In the absence of an agreement to the contrary, each partner has an equal right to participate in the management and control of the business. Each partner may be held jointly and severally liable for a copartner’s wrongdoing or tortious act (e.g., the misapplication of another person’s money or property). In a general partnership, each partner is deemed an agent of the partnership, such that any partner apparently carrying on partnership business can bind all of the partners, making them personally liable for the resulting obligations. What’s worse, each partner can be held liable for each other partner’s wrongdoing or tortious act, such as their embezzlement or professional malpractice.

 

2. Limited Partnerships

Under the 2001 Uniform Limited Partnership Act, limited partnership rules are stated independently of the rules for general partnerships and limited liability companies. As a stand-alone body of law, the new Limited Partnership Act incorporates many provisions from RUPA and the Uniform Limited Liability Company Act (ULLCA), making it long and complex.

The 2001 Uniform Limited Partnership Act takes into account the widespread use of LLPs and LLCs under circumstances in which limited partnerships used to be the norm. It also accommodates the more narrow circumstances in which the limited partnership remains a preferable form of entity, namely (i) sophisticated, manager-entrenched commercial deals whose participants commit for the long term, and (ii) estate planning arrangements (family limited partnerships). Therefore the Limited Liability Act was drafted to support, and defaults to, strong centralized management that is strongly entrenched and passive investors with little control over or right to exit the entity.

 

What Formalities Must Be Observed?

The formalities required depend on the type of partnership and the terms of the partnership agreement. They can vary widely.

 

What Are the Tax and Regulatory Obligations of a Partnership?

 

1. Taxes

Income in partnerships is allocated among the partners and is not taxed at the entity level (i.e., partnerships are pass-through entities for tax purposes). Therefore, partnerships are required to file information returns, rather than filing income tax returns like all other forms of business. Information returns report the operation’s income, deductions, gains, losses, and so on that are passed through to its partners. All partners must include their share of these items on their individual tax returns. Partners may be required to pay estimated federal income tax in installments.

The partnership will be required to withhold federal income tax and social security tax from taxable wages paid to its employees and deposited periodically with the appropriate Federal Tax Deposit Form. An Employer’s Quarterly Federal Tax Return (IRS Form 941) must then be filed before the end of the month following each calendar quarter. The partnership may also be required to withhold state income tax from its employees’ taxable wages.

 

2. Renewals

Legal requirements, such as annual state filings and the payment of annual fees, are required of limited partnerships, but not of general partnerships.

 

3. Employer ID

Every new employer must obtain a Federal Employer Identification Number (FEIN) that will be used on partnership information returns and certain other documents. A FEIN can be obtained by application to the Internal Revenue Service on Form SS-4.

 

4. More Taxes

If the partnership owns significant personal property, it may be required to file a property statement with the county assessor and may be subject to a personal property tax. Information and forms may be obtained from your county assessor, where applicable. If the nature of the corporation’s business includes the sale at retail of tangible personal property (goods), then the corporation may be subject to sales and use taxes and would need to obtain a sellers’ permit from its state and local authorities.

 

5. Business Licenses

Most municipalities require that businesses within their jurisdictions obtain a local business license.

 

6. Industry Regulation

Numerous regulated businesses cannot lawfully be conducted without special licensing or permits (e.g., general contractors, insurance sales, and cosmetologists). Make sure you know what regulatory requirements are unique to your business.

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Advising the Small Business

Did you find this article helpful? Do you think more information like this would help you? More information is available. This material is excerpted from pages 335–38 of Advising the Small Business, 2011, by Jean L. Batman, published by the American Bar Association General Practice, Solo and Small Firm Division. Copyright © 2011 by the American Bar Association. Reprinted with permission. All rights reserved. This information or any or portion thereof may not be copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of the American Bar Association. GP/Solo members can click here to purchase this book at a discount.

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