Partnerships - Easy, But Limited and Potentially Risky

1. What are Partnerships? How are partnerships formed?

Why should the small business owner or start-up company care about S-Corporations, when a general partnership is so easy. Very little is needed to start a general partnership, aside from the intention of the partners to form a partnership for a business and to share profits. NCGS 59-36(a) states that a partnership is an association of two or more persons to carry on as co-owners a business for profit. Partners can agree in writing or can agree to a partnership orally. In the absense of a written agreement, Article 59 of the North Carolina General Statutes provides certain terms that are universal to any partnership formed in the state of North Carolina. Among them, that partners' share profits and losses equally and have an equal say in the management of the partnership. In addition, partners have equal rights in the partnership property, regardless of who contributed the property. Finally, upon dissolution, partners receive back an amount equal to their contribution, and any excess was divided equally among the partners.

But this describes only general partnerships, and doesn't include limited partnerships and limited liability partnerships. In a limited partnership, only the general partners are personally liable for the actions or debts of the partnership, while the limited partners only risk their investment in the limited partnership. In limited liability partnerships, none of the partners are personally at risk for more than their investment in the limited liability partnership. Of course, many times partners are required to personally guaranty loans or other obligations undertaken by the partnership by those loaning money or leasing equipment.

2. Partnership Taxation.

Partnerships file one entity level tax form with the IRS - form 1065. However, no tax is paid at the entity level and the form is merely informational. Instead, the partnership files form K-1 with the IRS when it files its IRS Form 1065 which allocates to each partner a share of the profits, losses, and/or deductions of the partnership in proportion to the ownership interests of the partners. For example, a partnership with $100,000 in partnership profit would allocate $65,000 to its partner who owns 65% of the partnership interests and 35% to the partner with 35% of the partnership interests.

3. Asset Protection.

Partnerships offer intermediate asset protection. Unless the partner is a limited partner, or a limited liability partner, the general partner's assets are personally at risk for debts or liabilities of the partnership. On the other end, if a debtor comes against the partner, are the partnership's assets at risk? A creditor who attaches the partnership interest of a partner/debtor is only entitled to a "charging order" entitling that creditor to receive the distribution that would normally accrue to the partner alone. So when distributions are alloted, the share of the partner/debtor is given to the creditor. However, the partnership, provided their partnership agreement provides so, can withhold the distribution of the partner so that the debtor will not receive it, meanwhile, the debtor must pay taxes on the amount of distribution that would have been paid.

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