When forming a new business, it is important to select an appropriate business structure. You may consider a number of factors, such as the length of the business venture, the nature of the business and the level of involvement by the investors. Partnerships are a common option because they are relatively simple to set up and allow for a variety of management structures. A partnership may be formed as a general partnership, limited partnership or limited liability partnership.
A general partnership is the most informal partnership structure. In many states, a general partnership is formed whenever two or more people start doing business together, and no formal registration is required. In a general partnership, the owners are personally liable for the debts of the business. Profits, liability and management responsibilities are shared equally among the partners unless otherwise specified in a partnership agreement.
A limited partnership, or LP, is a more complex business structure. An LP is composed of general partners and limited partners. Limited partners are passive investors who may provide startup capital and receive profits from the business, but they do not have a say in how the partnership is managed. The general partners are responsible for making management decisions. An LP must have at least one general partner and one limited partner, and some states may limit how many limited partners an LP may have. General partners in an LP remain personally liable for the debts of the partnership, but limited partners are not liable. As a result, limited partners must be careful to not involve themselves in management decisions or they may be treated as general partners and will be liable for the debts of the business.
Limited Liability Partnerships
In a limited liability partnership, or LLP, every partner may act as a general partner and a limited partner. All partners in an LLC are allowed to participate in the management of the business, and no partner is liable for its debts. LPs can be formed by anyone, but in many states, LLPs can only be formed by professionals, such as lawyers and doctors, to help limit malpractice liability.
All partnerships are considered "pass through" entities by the Internal Revenue Service. This means that the partnership does not pay business taxes on its income; instead, the partners report the business income on their personal taxes. Depending on the type of partnership, the income may be treated differently by the IRS. General partners report partnership profits as earned income, while limited partners generally report profits as dividend income. Another important difference is that limited partnership interests are considered securities, which is not the case with a general partnership or LLP. As a result, different tax consequences may arise when selling an ownership interest as a limited or general partner.