Partnership Profit-Sharing Agreements

By Elizabeth Rayne

When two or more people decide to start a business for a profit, the resulting agreement is called a partnership, governed by state law as well as individual contracts. Following the creation of the business, the execution of a profit-sharing agreement is an important step in properly allocating profits and losses between partners and determining individual tax liabilities. If prepared properly, this written document will represent the true intentions of the partners. It does not necessarily need to be based on ownership percentages.

When two or more people decide to start a business for a profit, the resulting agreement is called a partnership, governed by state law as well as individual contracts. Following the creation of the business, the execution of a profit-sharing agreement is an important step in properly allocating profits and losses between partners and determining individual tax liabilities. If prepared properly, this written document will represent the true intentions of the partners. It does not necessarily need to be based on ownership percentages.

Ownership Interest

In the absence of a partnership agreement, the ownership interest in a partnership is split evenly among the partners. When ownership interests are equal, the profits and losses of the business are also shared equally. Unlike in corporations and limited partnerships, ownership interests are not automatically determined by the amount of capital each partner contributed to the business, although the partnership agreement may provide otherwise.

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Partnership Taxation

Partnerships are responsible for reporting the income and losses of the business to the IRS. However, partnerships are not responsible for paying corporate income tax. Instead, each partner is allocated a share of the business profits and losses, which he reports on his personal income tax return. Instead of issuing a W-2 to each partner as businesses do for employees, partnerships distribute Schedule K-1, Form 1065, to each partner.

Ownership and Distributions

Unless otherwise specified in a partnership agreement, the ownership, managerial responsibilities and profit distribution will all be equal among the partners. However, the partnership agreement may provide that the ownership percentage does not correlate to profit distribution. Unless otherwise provided by the agreement, the partners will share the losses of the partnership in proportion to the profits. Partnerships have the right to agree to profit/loss allocations that work for the business. For example, a partnership can allocate one partner more of the profits for the first three years of the partnership to compensate him for bringing an important relationship to the table

Profit-Sharing Agreement

A profit-sharing agreement is a written contract, signed by all partners, that specifies how profits and losses will be allocated to the partners. Generally, profit-sharing is a part of the partnership agreement, which will also specify the rights and responsibilities of the partners in managing the business. The agreement may also specify how much each partner is expected to contribute to the business, and how the partners may be compensated in their roles as managers. With a partnership agreement, partners may create a profit-sharing arrangement as simple or as complicated as necessary for the business.

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How to Prepare a Partnership Agreement

References

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What Constitutes a Legally Binding Business Partnership?

A partnership is a common legal structure that two or more people can use to manage a business together. The business is formed as soon as two individuals start doing business together, but you may formalize the arrangement by registering with the state or drafting a partnership agreement. The business owners of a partnership have flexibility in how they want to run the business, while the partners remain personally liable for the debts and responsibilities of the business.

What Is a Wyoming Limited Partnership Agreement?

A limited partnership is a common business entity, and the creation of a partnership agreement is one of several important steps in formalizing the business. In short, a limited partnership agreement outlines how the partners will conduct their business. After the limited partnership is formed, the business has a number of legal responsibilities to remain in compliance with Wyoming law.

How to Incorporate a Partnership

A partnership may decide to incorporate for many reasons. A corporation protects its shareholders from the business’s liabilities while a partnership does not. A corporation is also often better suited to obtain outside investors. Both partnerships and corporations are subject to state law, so the conversion process will vary. Consult your state’s partnership and corporation laws before attempting to convert your business.

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