Business partnerships: Everything you need to know

Collaboration drives innovation and the exploration of new and novel ideas. In the world of business, collaboration can be vital to growth and success. When this collaboration leads two or more people to start a new business together, it’s called a business partnership.

Business partnerships are legally binding agreements between two or more people setting up ownership of a business. In this article, we’ll explore business partnerships in detail, covering:

• What is a business partnership?
• The four types of partnerships
• Seven steps to forming a partnership
• Five common partnership problems with solutions

We’ll also discuss the differences between partnerships and other similar business structures, plus partnership tax implications for business owners and the importance of planning ahead for tax filing.

What is a business partnership?

A business partnership is a structured legal agreement between two or more people or entities that gives each party ownership of, and often responsibility for, the business. In a partnership, each party invests money into the business and can expect a share of any profits or losses from it.

Similar to a sole proprietorship, a partnership grants each owner shared control and doesn’t create a legal distinction between the owners and the business. This is different from corporations or limited liability companies (LLCs), which can guard owners against certain responsibilities for debts and liabilities.

There are two types of partners, depending on the classification of your business partnership. Each type balances liability and business management:

• General partners have unlimited liability and full control of the business.
• Limited partners have limited liability and little to no control of the business.

Before opting to form a partnership, it’s important to understand what liabilities you may face as either a general or limited partner. Limited partners are only subject to liability that matches the investment they put into the partnership, but sacrifice managerial control over much or all of the partnership’s affairs.

How are partnerships taxed?

A partnership itself doesn’t pay income tax. Instead, any income tax due passes through the business to the partners who pay taxes on their personal income share, while the business files Internal Revenue Service (IRS) Form 1065 (Schedule K-1) notifying partners of their tax liability. Owners then report their portion of earnings on Schedule E of their personal returns.

An exception to this is if you go into business with your spouse, you both materially participate in the business, and the two of you are the only members of your partnership. In this case, the IRS allows you to file as a qualified joint venture and report business income and losses on Schedule C of your 1040.

Partnerships and self-employment tax

Regardless of who your partnership consists of, you’ll have to pay self-employment taxes on your partnership income. Depending on what type of partner you are, your tax liability could differ.

• General partners pay self-employment taxes on their share of all partnership profits.
• Limited partners pay self-employment taxes on guaranteed payments, like a partnership salary.

There are many tips and tricks to filing small business taxes, but a partnership has advantages compared to other business entities depending on your goals. 

Business partnership vs. sole proprietorship

Partnerships and sole proprietorships are similar in how they’re structured and taxed, but the main difference is the number of owners involved. In a sole proprietorship:

• There’s only one owner instead of multiple
• The owner reports income on Schedule C of their personal tax return

Both sole proprietors and partners are subject to liabilities through their businesses, but can protect themselves with limited liability structures.

Business partnership vs. joint venture

Though they may sound interchangeable, business partnerships and joint ventures serve different purposes. In a joint venture:

• Two or more parties agree to complete a task or project
• Scope of the agreement is limited and ends sooner than a partnership

While you may form a partnership for the purpose of creating a new business, a joint venture helps accomplish a specific purpose and ends once that goal is accomplished.

4 types of partnerships

The type of partnership that’s right for you depends on your relationship with your fellow partner(s), the nature of your work, and the liabilities you might be exposed to. There are four different types of partnerships:

1. General partnerships
2. Limited partnerships
3. Limited liability partnerships
4. Limited liability limited partnerships

Each type has its own advantages and disadvantages relating to management structure and liability exposure. Read on below for an overview of each.

1. General partnership (GP)

A general partnership grants ownership and managerial responsibilities to the owners. Partners in a GP:

• Have full management control
• Take part in day-to-day operations
• Face unlimited liability for debts and legal issues

While GPs often see partners split profits and responsibilities equally, they can define terms in a partnership agreement that state otherwise.

2. Limited partnership (LP)

Limited partnerships offer more flexibility in the role of partner pertaining to personal liability and business management. Partners in an LP:

• Can be either general or limited partners, or both
• May formally change their partnership terms between limited and general
• Use a partnership agreement to define their roles and responsibilities

A limited partner can decide to take on a managerial role that opens them up to unlimited liability. Often, limited partners’ actions are restricted to avoid assuming unwanted liabilities.

3. Limited liability partnership (LLP)

While a limited partnership offers owners more flexibility with their role in the business, a limited liability partnership offers liability protection to all owners. Partners in an LLP:

• Face limited liability based on their contributions
• Can only be limited partners
• Are protected against liability from fellow partners

It’s common for partners in an LLP to work in the same profession, like accounting or law, because an LLP offers all partners the same liability protection without asserting anyone as a general partner.

4. Limited liability limited partnership (LLLP)

A less common and newer type of business than the other three partnerships, a limited liability limited partnership blends elements of an LP and an LLP. LLLP partners:

• Can be either general or limited partners, or both
• Use a partnership agreement to define their roles and responsibilities
• Are protected from liability regardless of their partnership status

LLLPs aren’t recognized or authorized in every state, so if you’re interested in forming one, you should check with the secretary of state’s office in the state you wish to do business.

How to form a partnership in 7 steps

Once the partners are decided and you’ve determined which type of partnership is the right one for your business, it’s time to start thinking about business formation. The steps to form a partnership include:

1. Choose a name
2. Register the partnership
3. Apply for an EIN
4. Draft a partnership agreement
5. File for licenses and permits
6. Start a business bank account
7. Prepare for filing taxes

Follow along below to get a clear understanding of the formation process for your business partnership.

1. Choose a name 

Your partnership’s name is often its first impression to others. Choose a business name that makes you proud to share it with the world. Ensure that it:

• Includes partner names, if necessary
• Hasn’t been claimed by another business

Some partnerships utilize the names of the partners while others don’t. Your business’s name may need to include your name depending on the type of partnership and your state’s rules.

2. Register the partnership 

Your business partnership is on its way once it has a name, but it’s not official yet. Before you officially start your business, you’ll need to register your partnership through the secretary of state in the state where your business will operate. There are in-state and out-of-state partnership classifications:

• Domestic partnership: Operates in the state where it was founded
• Foreign partnership: Operates in a state other than where it was founded

You’ll need to register your partnership in every state where you plan to do business, whether you maintain a physical presence there or not.

3. Apply for an EIN

While your partnership income passes through the business to be taxed as self-employment income, the partnership will need an Employer Identification Number (EIN) to file Form 1065 and trigger that taxation process. Depending on where you’re located and what industry you’re in, you may also need:

• Federal, state, and local tax ID numbers
• Business tax ID numbers, like tax permits

There is no cost to apply for an EIN, but be sure to check with your state and local officials to determine any filing costs associated with permits or state and local ID numbers.

4. Draft a partnership agreement

A partnership agreement is a catchall for partner roles, duties, and liabilities. This legally binding agreement contains specifics on important matters like:

• Profit distribution, including how owners are paid
• Conflict resolution, like when to use mediation

In most states, a partnership agreement isn’t required. However, it’s recommended to all partnerships because without one, your partnership is governed by generic guidelines issued by your state.

5. File for licenses and permits

Though not necessary for all partnerships, some state and local guidelines require certain business permits and licenses. These might include:

• Building or construction permits
• Sales tax permits or resale certificates

You may also be required to obtain a doing business as (DBA) license if you choose to operate under any moniker other than your official partnership name. Be sure to check with state and local officials to determine exactly which licenses and permits are required in your area.

6. Start a business bank account

When you launch your business partnership, you’ll need somewhere to write and deposit checks, make purchases, and transfer funds. While it’s not required, it’s a good idea to open a business bank account to avoid confusion when it comes time to file taxes. With a business account, you can:

• Keep your business and personal expenses separate
• Utilize automated accounting to keep transactions organized

With a separate business account, you’ll avoid the hassle that comes with separating business expenses from personal ones when it comes time to file.

7. Prepare for filing taxes

Before you file, you’ll need to know what your tax obligations are. Partnership income passes through the business, meaning it’s reported on your personal tax return. To avoid missing important filing dates and getting confused about what information you need to include when filing, it’s helpful to hire a bookkeeper. They can:

• Prepare your books for filing to ensure accuracy
• Meet with you regularly so your books never fall behind

If your partnership conducts business that’s relatively uncomplicated and you feel comfortable preparing your books yourself, it can still help to look into accounting software solutions that help keep business finances organized.

5 common business partner problems with solutions

Since a partnership takes serious investment, it can be helpful to think of that partnership like a marriage. Many successful marriages are built on strong foundations of trust, communication, shared values, and similar goals. Successful partnerships need these same values to prosper, and you may find problems quickly arise if these values are lacking.

Here are five common problems and simple solutions that might help you position your partnership for success.

1. Letting trust dissolve 

Open and honest communication among partners is critical to give each a complete grasp of business operations. It’s commonplace to split responsibilities among partners, but this can lead to vital information slipping through the cracks if one or more partners is not being transparent.

Solution: Communicate openly and regularly

Depending on the nature of your work and your role in the partnership, it may make sense to have weekly or monthly meetings among partners.

This gives you an opportunity to convene to answer questions and solve ongoing problems that might’ve been otherwise overlooked. It also gives you the opportunity to avoid miscommunication that could lead to conflict.

2. Stressing about performance

Partners’ investments can be directly tied to the partnership’s performance. You might feel pressure if your business is falling short on goals and performance targets. 

This pressure can bubble over into your day-to-day operations, like your interactions with other partners, and negatively affect your partnership.

Solution: Find an outlet for stress

In and out of the workplace, stress management helps restore balance and alleviate frustration. Physical activity, laughter, and a healthy diet are all proven remedies for stress. 

Connecting with other partners outside of work can also provide a distraction from work stress. This kind of bonding may help you make more rational decisions in the workplace that aren’t as influenced by negative emotions.

3. Feeling inequity or imbalance

You may find that once your partnership launches, you’re handling more or less of the work share than you would like, or that power isn’t split equitably between partners.

Feelings may also surface about imbalances in financial equity, such as one partner believing they’re receiving an unequal share based on their investment in the partnership. These feelings can cause serious consequences to the health of the business if they’re not quickly resolved.

Solution: Draft an ironclad partnership agreement

In an ideal partnership agreement, each party’s role in the business is laid out explicitly. This includes managerial responsibilities, decision-making duties, and share of profits and liabilities, among other things.

While it may take time for all partners to reach consensus about the contents of a partnership agreement, coming to these conclusions before launching a business is crucial for its long-term health.

4. Leaving boundaries unenforced

It’s not recommended to mix the professional with the personal when it comes to business expenses, and the same goes for partnerships.

While some partners may have relationships that extend beyond business, it’s important to set boundaries as to how those relationships manifest. Bringing outside problems to work can strain relationships between partners.

Solution: Set expectations

The most direct way to avoid clashes over work and non-work feelings is to set expectations around the time and manner these feelings can be discussed. 

For yourself, try to avoid discussing personal subjects when emotions are running high. For others, have a chat with your fellow partner to determine how much discussion of personal feelings is appropriate and what topics to leave off the table.

5. Splitting on personal values

Personal values influence the thoughts we think and the decisions we make, even at work. It can be difficult to imagine all the future instances where you and your fellow partner might disagree, but workplace conflicts, especially between partners or owners, are serious business.

Overlooking a big disagreement in values can be detrimental to not only the success of the business, but the foundation of your partnership as a whole.

Solution: Map out your values

Before setting out to register your business or even choose a name, it’s a good idea to sit down with the other partners to map out your values and priorities to see how they align and how they differ.

These values will likely inform the values you set for your partnership, and in turn, a discussion around values will set the tone for many future discussions or disagreements. If it turns out that many of your values are contradictory to your partner’s, it may not be a good idea for you to start a partnership.

Ready to partner up?

Starting a partnership can be thrilling. It’s a chance to grow and manage a small business with someone else and share in the rewards. It can also be an opportunity for you to focus more on your individual entrepreneurial strengths—especially if you have a partner who complements those strengths.

Prepare ahead and ask plenty of questions to ensure that your partnership is built on a solid foundation. If you have additional questions, it can help to speak with a professional for extra reassurance when starting up a new business.