A business partnership is an agreement between two or more individuals who go into business together. There are several types of partnerships that business owners can create, such as a general partnership, limited partnership, LLC with multiple members, and limited liability partnership (LLP). Regardless of the partnership you choose, we recommend creating a documented agreement and registering the business as a legal entity.
Types of Business Partnerships
Most small-to-medium sized partnerships choose to be an LLC with multiple members (owners), however, we’re going to describe all types of available partnerships. You need to be aware of the different types if they come up in conversation with an attorney or on a government website.
- General Partnership (GP): This type is similar to a sole proprietor, except with more than one owner. Each partner has equal ownership in the business. It’s simple to set up a GP—register your partnership a “doing business as” (DBA) with the state, and open a bank account.
- Limited Partnership (LP): The LP includes a limited partner in addition to the general partner. The limited partner is typically an investor and isn’t involved with day-to-day operations. Usually, the general partner is a corporation, not an individual, because the LP doesn’t provide personal liability protection for the general partner.
- Limited Liability Company (LLC) with multiple members: This type is the partnership of choice for most small businesses. The LLC has a flexible structure—a partnership agreement outlines the ownership share and duties of the LLC members (owners), which may also be called the LLC operating agreement.
- Limited Liability Partnerships (LLP): This LLP is similar to an LLC, but it’s for professional-based businesses such as doctors, lawyers, and accountants. The LLP provides additional liability protection for each partner, so the negligence of one doesn’t affect the liability or finances of another.
How Partners Are Taxed
The GP, LP, LLP and LLC are all taxed the same—at the individual tax rate level.
The LLC, however, has additional tax flexibility. A limited liability company can elect as S corporation status and provide substantial tax savings for its members (partners). Here’s an example for clarification:
Let’s say two partners have a 50/50 ownership split of a company. If that company earns $150,000 in net profit, each partner is paid $75,000. The amount each partner owes in a 15.3% self-employment tax is $11,475 ($75,000 x 15.3%).
If the LLC is elected S-corp tax status, there is potentially a large amount of tax savings. When electing S-corp tax status, each partner takes a “reasonable” salary for the position. On any net income in addition to the salary is considered a dividend. What’s great about a dividend is no self-employment taxes are paid.
Going back to our previous example of $150,000 in net profit: if each partner paid themselves a “reasonable” salary of $50,000, they would each have a $25,000 dividend. They would only pay a 15.3% self-employment tax on the $50,000 salary, which would be $7,727 in taxes on $150,000 in net profit.
Electing the S-corp tax status on the LLC would save each partner $3,749 in taxes ($11,475 – $7,727)!
How to Set up a Business Partnership
A business partnership can start with a handshake; however, you should take the steps to register your partnership as a legal entity to protect personal assets from a lawsuit or creditors. Here are the steps you need to take to set up a multi-member LLC:
- Draft a Partnership Agreement or LLC Operating Agreement
- Have an attorney review the Partnership Agreement
- Choose a public-facing name for the partnership
- Register the partnership as an LLC with the state’s official business registration website or through an online legal service—expect to pay anywhere from $40 to $500 for this registration
- Publish a notice in local newspaper announcing your new LLC partnership—this is an archaic process that is still required in many states
What’s a Partnership Agreement?
Getting into a business partnership is like a marriage. If the relationship breaks apart, it can have severe legal and financial consequences. Before starting any partnership, a vital legal step is creating a partnership agreement.
This agreement outlines the basic structure of the partnership, like the business’s purpose and percentage of ownership. It will also be the legal document that determines what to do in a challenging business situation, such as an illness or an exit.
Note: The partnership agreement is not a requirement by the state. If you’re registering the business as an LLC, then the LLC operating agreement may include partnership information. Additionally, you can draft each document separately.
You can draft your own partnership agreement or hire a business attorney to draft one for you. If you’re creating your own agreement, then we recommend you have an attorney review the document for any inaccuracies. If you’re starting a business on a budget, consider having an attorney at Rocket Lawyer review your document for around $50. If you have a more complicated document that needs to be reviewed, consider getting advice from a local business attorney.
A Business Partnership Alternative
Now that you understand what a general partnership and an LLC with multiple members is, you may be wondering where a C corporation fits in.
Most small-to-medium-sized businesses will not register as a C-corp. The maintenance is too time-consuming, and the taxes are too expensive. C corporations are taxed twice—at the corporate level (21%) and the individual level.
Some smaller businesses, such as startups, may choose to be a C corporation. The C-corp is a structure friendly toward investors because it allows for unlimited shareholders, whereas the S-corp must have under 100 shareholders. Also, a C-corp has a lower tax rate (21%) if the owners plan on keeping a substantial amount of profit in the business.
If you’re interested in raising capital for your partnership, or substantially re-investing profits back into the business, it’s best to talk with a business attorney regarding your specific situation.
The business partnership is an exciting undertaking. You’re joining forces with one or more individuals to build a successful company. Depending on the makeup of your company, make sure to choose the best partnership structure for you. Then, draft a partnership agreement to make sure each partner is on the same page about the future of the company. Before taking on any customers, register as a business legal entity such as a multi member LLC to avoid any personal liability.