Many businesses are structured as general partnerships.
General partners share both the benefits and obligations of the business. This lesson explains general partnerships, including the advantages and the liabilities.
Partnerships are the most common type of business structure for businesses with more than one owner. A business partnership is a for-profit business established and run by two or more individuals. The individuals are partners and serve as co-owners of the business.There are actually several different types of business partnerships.
The most common is the general partnership because it’s the easiest, most straightforward and least expensive to form. It’s a partnership where all partners have responsibility for the business and unlimited liability for business debts. This means that each general partner shares both the benefits and the obligations of the business.Each general partner must contribute something to the partnership business. The partner can contribute funds, property, skills, labor or most any kind of involvement with the business.
In return, each general partner shares the business profits. However, general partners also share the business’ liabilities and losses.For example, let’s say that Dottie and Dave decide to open a clothing store. They decide to name the store D.
D.’s Duds. Dottie and Dave don’t need to do anything special in order to form a general partnership. Once Dottie and Dave agree to form the business, it’s automatically considered to be a general partnership.
Remember that each general partner must be involved in the business in some way. At D.D.’s Duds, the partners agree that Dottie will be responsible for buying the clothing and stocking the store.
Dave will be responsible for everyday store operations. Both partners will contribute money toward establishing and funding the store. Dottie and Dave will split any business profits.
If the store loses money, then they’ll also split the losses. Dottie and Dave have a typical general partnership.
General partnerships, like all partnerships, are popular due to the advantages they provide. The main advantage of all partnerships is that the partnership isn’t separately taxed.
The IRS doesn’t treat a partnership as a separate tax entity, and therefore doesn’t require taxes on business profits.Instead, the profits flow through directly to the partners. The business profits become the partners’ income.
The partners then file their own individual tax returns and pay their own individual income taxes.For example, let’s say that Dottie contributed 60% of the funds needed to establish D.D.
‘s Duds. Dave contributed 40%. Dottie and Dave execute an agreement to split their business profits along these same lines, meaning Dottie will receive 60% of the profits and Dave will receive 40%. The business makes $100,000 net profit in its first year. Dottie therefore receives $60,000 for her income, and Dave receives $40,000 for his income.
Because the business isn’t separately taxed, D.D.’s Duds won’t pay taxes on its $100,000 profit. Instead, Dottie will pay individual income taxes on her $60,000 share, and Dave will pay individual income taxes on his $40,000 share.Though tax treatment is the main advantage, keep in mind that general partnerships are also popular because they grant broad powers to the partners. The partners share responsibility for the management of the business and act as their own bosses.
General partnerships are also easy and inexpensive to form. Recall that, unlike other forms of partnerships, there’s no requirement for formal paperwork in order to form a general partnership.
Now let’s take a look at the main disadvantages of a general partnership.
Unlike other forms of partnership, all general partners have unlimited liability for partnership obligations. This means that all general partners can be held personally responsible for all business debts and liabilities, including financial commitments and court judgments.This means that, unless there’s an agreement otherwise, any general partner has authority to transact business on behalf of the business, and therefore obligate the business. Dottie has the authority to buy clothing and stock the store, so she can sign contracts and commit to business deals that obligate D.D.
‘s Duds and both general partners.For example, let’s say that Dottie is convinced that overalls will be the next best-selling clothing trend. Dottie orders $10,000 worth of Oliver’s Overalls to sell in the store.
Oliver’s sends the overalls and a $10,000 invoice to D.D.’s Duds. The overalls don’t sell, so D.D.
‘s Duds is stuck with the extra clothing and doesn’t have the money to pay Oliver’s invoice.If D.D.’s Duds doesn’t pay Oliver’s, then Oliver’s is entitled to seek payment from any, or all, general partners. This means that Oliver’s can seek payment from Dottie and Dave personally.
Oliver’s may even be allowed to put a lien on Dottie or Dave’s cars, houses or other personal possessions in order to collect the overdue bill. Just keep in mind that Oliver’s is only entitled to be paid once. For instance, Oliver’s can’t recover full payment from Dottie if Dave already paid the bill.
Though personal liability is considered to be the main disadvantage of a general partnership, there are other disadvantages. One disadvantage is that partners generally must consult other partners when making business decisions, and disagreements can be common. Additionally, keep in mind that business profits are shared even when one partner feels there’s been an unequal commitment of time, effort or resources.
Let’s review. Many businesses are structured as partnerships.
A business partnership is a for-profit business established and run by two or more individuals. There are several different types of business partnerships. The most common is the general partnership. It’s a partnership where all partners have responsibility for the business and unlimited liability for business debts. The general partners share the benefits and obligations of the business.
The main advantage of any business partnership is that the partnership isn’t separately taxed. The IRS doesn’t treat the partnership as a separate tax entity. Instead, business profits flow through directly to the partners and become the partners’ income. The partners then pay their own individual income taxes.
Other advantages for general partnerships include:
- Broad business management powers for each partner
- Easy and inexpensive formation with no formal requirements
The main disadvantage is that general partners have unlimited liability for partnership obligations. This means that all partners can be held personally liable for all business debts and liabilities, including financial commitments and court judgments.Other disadvantages for general partnerships include:
- Partners must usually consult other partners when making business decisions
- Business disagreements can be common
- Business profits are shared even when a partner feels it’s unfair
When this lesson is done, you should be able to:
- Define business partnership
- Understand why general partnerships are the most common business partnership
- Discuss the advantages and disadvantages of general partnerships