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What's Involved in Starting a Partnership?
by Nellie Akalp
April 6, 2023
black woman and white man look at laptop together

Entrepreneurs who plan to go into business with one or more other individuals may not realize there are several variations of partnerships to consider. In this article, I’ll describe the different types of partnerships and what needs to be done to start and maintain them. 

Business owners should keep in mind that there are legal and tax-related issues to consider when choosing a business entity type. So before deciding, it's wise to consult an attorney and accountant or tax advisor for guidance.

First Things First: What is a Partnership?

A partnership is when two or more parties ("partners") agree to go into business together and share profits and losses. Partners' obligations in managing the company and their degree of personal liability for the debts of business vary depending on the type of partnership. Income tax responsibilities of partnerships pass through to the business owners' individual tax returns. Although partnerships do not pay income tax at the company level, they do have reporting responsibilities to fulfill. Therefore, they need an EIN (Employee Identification Number) from the IRS for tax-reporting purposes.

To follow, I’ll cover information about the three most popular types of partnerships:

  • General partnership
  • Limited partnership
  • Limited liability partnership

1. General Partnership (GP)

This is the most basic form of partnership and does not usually require entity registration paperwork with the state. In a general partnership, ownership and profits are split equally between the partners unless the terms of the partnership state otherwise. All partners share responsibility for the company's debts and legal obligations because no legal separation exists between the business and its owners.

General partnerships are typically simple to form and maintain, so they are an attractive option for entrepreneurs who want to keep administrative and compliance responsibilities minimal.

They do not have restrictions on how many partners they may have. Owners of a general partnership are not considered employees of the company. Therefore, they do not receive a paycheck via payroll from the business. Partners usually get paid by withdrawing funds from their share of the profits (called taking an "owner's draw" or "partner draw"). General partners pay both income tax and self-employment taxes (Medicare and Social Security) on their share of business profits.

How to Start a GP

A partnership is established when its owners decide to do business together—even if there is no written plan or partnership agreement in place. To help ensure all partners are on the same page, it’s beneficial to have a partnership agreement that lays out the roles, responsibilities, and profit distribution of the business owners.  

A GP may continue to exist when partners leave the business if its partnership agreement allows it. Otherwise, the business may have to be dissolved.

Possible Ongoing Compliance Tasks for GPs

  • Report and pay income and self-employment taxes.
  • Register for a sales tax ID (seller’s permit).
  • Register for payroll taxes (if the business will have employees).
  • Obtain required business licenses and permits and keep them up to date.

2. Limited Partnership (LP)

Limited partnerships are business entities formally registered with the state. One reason entrepreneurs may choose this type of partnership is to have the ability to bring on partners to invest in the company without incurring the expense and paperwork of forming a limited liability company (LLC) or corporation. A partnership agreement is used to describe partners' responsibilities and document each partner's percentage of profits.

An LP has at least one general partner and one or more limited partners. Limited partners provide money but do not actively take part in running the business day to day. As such, they have the protection of limited liability (to the extent of their investment in the business) for the partnership’s debts and legal issues. An LP’s general partner(s) are tasked with handling the business operations and management. Those individuals have unlimited personal liability for the debts and legal issues of the business. So, creditors or lawsuits can go after general partners’ personal assets but not limited partners’ personal assets.

General partners in a limited partnership are also not considered employees of the company. Their income from partner draws or guaranteed payments to compensate them for their work in the business are subject to income tax and self-employment taxes.

In a limited partnership, limited partners make money from the business based on their share of the profits. The business may make periodic payments or partner draws to limited partners throughout the year. Because limited partners earn passive income from their monetary investment rather than income for any work done in the business, what they earn from the business is subject to income tax but not self-employment taxes. However, if a limited partner is paid guaranteed payments for any work they’re allowed to do for the business, that income is subject to Medicare and Social Security taxes as well as income tax.

How to Start an LP

Forming a limited partnership involves filing a Certificate of Limited Partnership with the state and paying the required registration fees. An LP must obtain an EIN from the IRS for tax reporting purposes.

Limited partners may leave the company or be replaced, and the LP may continue to exist. If a general partner leaves, some states require that the other partners dissolve the LP unless the business’s partnership agreement states otherwise.

Possible Ongoing Compliance Tasks for LPs

  • File an annual report with the state.
  • Assign and maintain a registered agent in the state.
  • Report and pay income and self-employment taxes.
  • Register for a sales tax ID (seller’s permit).
  • Register for payroll taxes (if the business will have employees).
  • Pay franchise tax.
  • Obtain required business licenses and permits and keep them up to date.
  • Keep a business’s and partners’ personal finances separate.

3. Limited Liability Partnership (LLP)

A limited liability partnership is similar to a general partnership—all partners may be involved in managing the business. However, unlike a general partnership, all of the partners are protected by limited personal liability. This form of business structure is usually used by entrepreneurs in specialized professions (for example, accountants, attorneys, accountants, wealth managers, engineers, architects, and doctors). Besides the benefit of personal liability protection, the LLP structure also gives professionals the ability to pool resources (such as administrative staff, equipment, etc.) and reduce operational costs compared to operating independently. Most states require that all partners in the LLP are licensed in the same profession. In an LLP, all partners are personally protected from the business's liabilities (the degree of liability protection they have varies by state) even though they have complete responsibility for the management of the business. Partners in an LLP get paid from the company's profits, and those draws are subject to income and self-employment taxes.

How to Start an LLP

The paperwork involved in forming an LLP is usually called a “Certificate of Limited Liability Partnership.” It must be filed with the appropriate state agency along with payment of the required fee.

It’s important to note that not all states recognize the LLP as an entity, and some states only allow certain types of professionals to form one.

LLPs may continue to exist when individual partners leave or pass away if the business's partnership agreement details those circumstances.

Possible Ongoing Compliance Tasks for LLPs

  • File an annual report with the state.
  • Assign and maintain a registered agent in the state.
  • Report and pay income and self-employment taxes.
  • Register for a sales tax ID (seller’s permit).
  • Register for payroll taxes (if the business will have employees).
  • Pay franchise tax.
  • Obtain required business licenses and permits and keep them up to date.
  • Keep the business’s and its partners’ personal finances separate.

Is a Partnership Right for Your Business?

The business structure you choose will be one of the most crucial decisions you'll need to make. Because your choice will affect so many aspects of your business—how you manage it, how taxes are handled, your level of personal liability, and more, consider getting guidance from trusted legal and accounting professionals. Every situation is unique in some way, so it's helpful to run through the pros and cons related to your specific circumstances before moving forward.

About the author
Nellie Akalp
Nellie Akalp is a passionate entrepreneur, business expert, professional speaker, author, and mother of four.
Read full bio
712 H St NE PMB 98848
Washington, DC 20002

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