General Partnership Definition: Taxes, Liability & Agreement

General Partnership

There are various types of business partnerships, the most common of which is a general partnership. A general partnership is formed when two or more parties agree to operate a company together without registering or incorporating the business. General partnerships are very common among the various types of business entities because they are simple to set up and file taxes.
If you’re going into business with partners, you should know how a general partnership differs from other forms of partnerships and business structures.
All general partners are responsible for business decisions under general partnership liabilities. You must understand what a general partnership entails, your liability risks, and what happens if you do not draft a binding agreement.

What is a General Partnership?

A general partnership is a business partnership formed between two or more individuals who have not filed corporate papers with the state. Each partner is responsible for the company’s sales, debt, gains, losses, and operations. The formation of a general partnership is easy. The simplicity, however, comes with a major risk: you and the company are inseparable. Partners in a general partnership, like sole proprietors, are individually responsible for the business. You are legally liable for any company debts or litigation.

Only the general partner who manages the firm is legally responsible for litigation and business debt if you form a limited partnership. The investing (or limited) partner is not directly responsible for any lawsuits or debts incurred. Limited partners are just at risk of losing the money they invested in the company. Since it is simple to create, some partnerships begin as general partnerships. However, as the company expands, these partnerships should convert to a limited liability company (LLC) to reduce liability.

How does General Partnership Work?

A general partnership is an unincorporated business, which means it does not need to be registered with the state in order to function legally. In reality, a general partnership occurs by default when two or more parties enter into a company together with the intention of making a profit.

More precisely, the partnership should meet two requirements in order to form a general partnership:

  1. The organization must have at least two shareholders.
  2. Both partners must agree to accept unlimited personal responsibility for any debt or legal liability incurred by the relationship.

Any partner in a general partnership has the authority to enter into contracts or business agreements that connect the other partners. Although this is convenient, it also implies that you should have complete confidence in the individual or people with whom you launch your business. It can be exciting to start a company with a friend or family member, but they may not be the best choice as a business partner. Your partner’s decisions or errors may have legal and financial consequences for you, as we’ll discuss in more detail in the following section.

General Partnership Agreement

Many general partnerships have a founders’ agreement in place to avoid and settle disputes. The general partnership agreement specifies the business’s governing structure as well as each owner’s rights and obligations. Usually, the general partnership agreement includes provisions for partner voting rights and benefit distribution.

General partnerships end when one of the partners dies, becomes disabled, or leaves the relationship in the absence of a partnership agreement. In these cases, an agreement will define what should happen. For example, if one partner dies, the surviving partner or partners can have the first option to purchase the partner’s share.

Features of a General Partnership

It does not take much to form a general partnership, but once formed, the implications can be significant, especially in terms of shared liability among partners. Here are some more specifics on what to expect from a general partnership.

#1. A general partnership has joint responsibility.

A GP is distinguished by mutual responsibility for partnership debts and obligations. Any GP partner risks unlimited personal responsibility for three reasons:

  • Their own choices.
  • The acts of the other partners tie the relationship together.
  • Employees’ behavior in the workplace.

If a general partnership is sued, the partners are jointly liable for any damages awarded by a judge or jury. This is a mutual responsibility. Some states go a step further by imposing joint and several liabilities. In that case, a debtor or legal claimant can sue any partner for the conduct of other partners. It is then up to the partners to figure out who owes whom. Shared responsibility in a general relationship can be especially damaging if one party is negligent or engaged in illegal activity.

An example is the most effective way to demonstrate shared responsibility among partners. Assume that Partners A, B, and C jointly own a hair salon business. Partner A injures a customer by mistake with a clipper while on a job one day. The client sues all three partners and obtains $1 million in damages. Partner A has very few personal properties, as evidenced in court. In states that follow mutual and several responsibilities, the client will recover full damages from the personal properties of Partners B and C even though they have nothing to do with the lawnmower accident. Later, Partners B and C can file a lawsuit against Partner A to recover money, but it might not be worth their time if Partner A does not have any money.

Fiduciary Responsibilities of a General Partnership

You may be shocked to learn that partners may be held accountable for actions they did not perform, but fiduciary obligations may help protect GP members. General partners have four forms of fiduciary duties:

#1. Duty of Good Faith and Fairness:

Partners must behave honestly and reasonably in all business-related activities.

#2. Duty of Loyalty:

Partners should prioritize the partnership’s interests over their own, and avoid any conflicts of interest that could damage the partnership.

#3. Duty of Disclosure:

Partners must report the possible advantages and risks of a prospective business decision that they know. This is so that the partners can make an informed decision about whether to undertake it. Partners may have to reveal details about business practices, finances, contracts, and so on.

#4. Duty of Care:

Partners must manage the relationship with fair care. Partners, for example, can document important business matters in writing and keep financial records.

These fiduciary duties begin with the formation of the partnership and continue until they dissolve the partnership. While state law may impose additional fiduciary duties, business owners may incorporate or change such fiduciary duties through a partnership agreement. If one of the partners violates a fiduciary obligation, the other partners have the right to sue.

General Partnership Taxes

Tax Obligation

Income tax is not levied on general partnerships. Partnerships, including sole proprietorships and limited liability corporations, are pass-through tax entities. This ensures that they pass partnership’s gains and expenses on to the business’s owners, who must report their share of the business’s income on their personal tax returns. This removes such tax problems, such as income double taxation, that companies organized as corporations must contend with.

Limited Partnership vs. General Partnership

The biggest benefit of limited partnerships over general partnerships is that limited partnership partners have limited legal responsibility for the obligations of their fellow partners as long as they are not personally involved in management. Limited partnerships, on the other hand, would pay an annual tax of $800 in some jurisdictions, such as California. General partnerships are exempt from paying an annual fee.

Distribution of Taxes

Unless there is a written agreement between partners, the Internal Revenue Service treats both partners equally when estimating taxes. This ensures that they charge you fairly whether you are a founding partner or a new partner who has no financial assets contributed to the partnership. Established partners benefit from this because their share of taxable assets in the business decreases when a new partner joins. If, on the other hand, you are a shareholder, you must consider the additional tax responsibility on your joint ownership of the company’s properties.

Estimated Taxes

General partnerships are exempt from calculating and paying projected taxes. This is a mere byproduct of being a pass-through entity exempt from income tax. However, depending on their circumstances, general partnership members may be required to pay quarterly estimated taxes. For example, partners who are US residents who plan to owe $1,000 or more in taxes must pay quarterly estimated taxes.

General Partnership Example

For example, suppose Roy and Joyce decide to open a dropshipping business. R&J logistics is the name of the business. Roy and Joyce are both general partners in the firm, R&J Logistics since they opened the business together.
It should be noted that each general partner must be actively involved in the company. For example, Roy may be in charge of sending orders to manufacturers, while Joyce is in charge of the distribution of products to distributors.

The profits from the company are divided equally between Fred and Melissa. At the same time, Fred and Melissa share joint responsibility for the store’s losses.

The Benefits of a General Partnership

There are many significant benefits to forming a GP:

#1. A general partnership is simple to form.

Forming a general partnership is less complicated, less expensive, and needs less paperwork than forming a company.

#2. The taxation of a general partnership is simplified.

Income tax is not levied on GPs. Profits and expenses are distributed to the individual partners.

#3. It is easy to break the partnership.

A partnership can be easily ended at any moment.

The Drawbacks of a General Partnership

There are two major drawbacks to forming a GP:

#1. Partners in general partnership face the possibility of limitless liability.

A general partnership does not constitute itself as a separate business organization from its partners due to the lack of corporate structure. Partners are unprotected from any claims filed against the company, and their personal assets can be confiscated to cover the company’s unpaid debt obligations.

#2. Partners are jointly and severally responsible for each other’s conduct.

Each partner bears responsibility for the actions of the others. If one partner executes an agreement without the other partners’ knowledge, the other partners are therefore bound to honor the terms of that agreement.

Other Partnerships

Aside from a general partnership, there are two other common forms of partnerships:

#1. Limited Partnership (LP)

In a limited partnership, at least one partner (the general partner) has unlimited liability, while the other partners have limited liability (limited partners). Limited partners are not actively involved in the management of the company and will lose no more than the amount they contributed to the partnership.

#2. Limited Liability Partnership (LLP)

There is no general partner in a limited liability partnership. Both partners are required to participate in company management, and all partners have limited liability. Professional service companies favor limited liability partnerships because the partners are not responsible for negligence lawsuits made against themselves or other partners.

Conclusion

When it comes to starting a business, you have four options: a corporation, a limited liability company, a sole proprietorship, and a partnership. The tax liability of a company varies depending on its business structure, and this is an important factor to consider when deciding on a structure. General partnerships, like sole proprietorships, are the easiest type of business arrangement to establish and do not necessitate any special forms or fees. A general partnership, on the other hand, provides few tax advantages to company owners.

General Partnership FAQs

What are the characteristics of general partnership?

It requires at least two partners. Each of the partners can obligate the general partnership. All of the partners have unlimited liability are liable for all of their own acts and omissions and those of the general partnership and of the other partners. Each partner is liable for all debts and obligations of the GP.

What do general partners do?

A general partner has the authority to act on behalf of the business without the knowledge or permission of the other partners. Unlike a limited or silent partner, the general partner may have unlimited liability for the debts of the business. … The main benefit of a partnership is that it isn’t taxed separately.

How do general partners get paid?

Compensation of General Partner

The GPs are either paid through a management fee or compensation. … GPs can also earn a proportion of the private equity fund’s profits, and this fee is carried interest.

How do general partners make money?

Managing multiple funds at once increases profit. In general, a venture fund lasts seven to 10 years and most firms try to raise money for a new fund every two to three years. The general partners earn money from every active fund, including both carried interest and management fees.

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