The general partnership (GP) is one of the most common business structures in operation today.
Most established business deals and new startups choose this structure for its simplicity and flexibility.
And, as a result, the profession of law has grown up around guiding GPs through their inevitable growth and evolution.
General partners (GPs) own and operate the business and take personal liability for any debts or lawsuits brought against the company.
General partnership features
1. Joint liability in a general partnership
Joint liability in a general partnership means all the partners of the joint venture are responsible for the business’s debts and legal judgments against it.
That means your personal assets – such as your home and car – could be at risk, even if you didn’t sign the checks or take part in any of the company’s day-to-day operations.
However, general partnerships enjoy several benefits that limited partnerships (LPs) don’t offer:
- Unlimited life;
- no annual meetings;
- fewer formalities;
- simpler tax filings;
- easy midstream changes to add new partners.
2. Fiduciary duties in a general partnership
GPs have a fiduciary duty to one another just as LPs do, but the scope of that responsibility is significantly higher.
In addition to being more complex, operating agreements outline all GPs’ functions and responsibilities within a business entity.
General partners face a high risk of personal liability for partnership debts and legal judgments against the firm.
All general partners share responsibility for any wrongdoing committed by other partners or employees, even if they had no knowledge it was going on.
3. Management and control in a general partnership
GPs have equal control over the business’s affairs, and none can act on behalf of another without written consent.
However, anyone who does not invest in the initial formation of a GP – such as family and friends – must receive general consent to join later on.
- General partners should consider potential repercussions before bringing new partners into the fold: New members might increase administrative costs or share liability for entity debts.
- A GP shouldn’t begin operating until it exists as a legal entity (corporation, LLC, or partnership).
- Before that point, GPs may lose their right to enforce contracts under state laws; invalidate any pre-existing agreements; and expose themselves to personal lawsuits.
4. Compensation in a general partnership
GPs can pay themselves any way they see fit – with salaries, dividends, bonuses, or non-cash compensation.
a) In fact, tax laws don’t require GPs to classify payments as anything other than ordinary business expenses.
b) In return for the lack of restrictions on compensation structure, GPs owe a fiduciary duty to one another.
c) They should consider potential repercussions before setting their own pay: The more partners receive in compensation, the less each will retain after paying personal income taxes.
d) Partnerships must withhold and make employer-level Social Security and Medicare payments for owners who work 30 hours per week or more for the company.
e) Those payments are called self-employment taxes because both employees and employers contribute toward them.
5. Taxes in a general partnership.
GPs must pay taxes on their share of the company’s business income at individual tax rates, just like limited partners.
But unlike LPs, general partners can take deductions for all of their legitimate business expenses on that same return – offsetting some or all of their taxable income.
Each GP is fully liable for any debts or legal judgments against the business (unlimited liability).
GPs also have unlimited life and continue operating until they choose to dissolve the partnership
Pros and cons
- Cheaper to establish.
- No annual meetings are necessary.
- Fewer formalities are required.
- Simpler tax filings with the IRS and state revenue services.
- GPs have unlimited liability for business debts and legal judgments against the partnership, which can lead to devastating financial consequences if a lawsuit is successful
- One GP can bind all partners through actions taken on behalf of the partnership without their written consent. This is known as “piercing the veil” of limited liability and has serious consequences for the partner who wants to leave or dissolve the entity in future years.
How much does it cost?
The amount of paperwork and bureaucracy involved in forming a general partnership depends entirely on the number of individual partners.
One partner usually requires less paperwork than two or more partners, but costs are shared by each business partner evenly.
Expenses for just one GP may include:
- The filing fee ($1 or $2 per page) to form the entity with your state’s Secretary of State office
- Business license fees ($100-$400) to operate legally within your home state
- Initial tax filings ($500+) with the IRS and any state revenue service you do business in
- Filing fees ($75-$350+), if any, associated with securing an employer identification number (EIN) from the Internal Revenue Service (IRS)
When you have multiple partners, additional paperwork is required – particularly if tax withholding is involved.
You may also need to hire an attorney or professional accounting service for assistance with complex legal and financial decisions.
Partnerships are always considered “pass-through” entities for tax purposes, which means business income passes through the partnership itself and gets reported on each individual partner’s personal income tax return.
General partnerships are subject to self-employment tax, which applies to any GP who works 30 hours per week or more for the company.
These taxes are paid by both employees and employers at a combined rate of 15.3% (for 2017). That same rate applies to GPs who receive distributions from the company as well as income from providing services to the partnership.
Is a general partnership right for you?
If you don’t plan to take on any additional partners and just want to operate as a single-member company, we recommend that you consider other business structures first.
Your expenses will be lower, and your profits won’t be taxed twice.
Other types of partnerships
1. Limited partnership (LP)
- Can have an unlimited number of partners
- LPs must have at least one general partner with unlimited liability, plus at least one limited partner who is only liable for the amount of his or her investment in the business. This is known as a limited liability
- Partners are taxed individually on their share of the profits (pass-through taxation) without having to pay self-employment taxes that come with operating a GP
2. Limited liability partnership (LLP)
- LLPs are similar to GPs in that they allow partners to operate a business with limited liability
- One major difference is that LLP members aren’t subject to self-employment tax on their share of profits. Instead, the LLP itself pays those taxes.
3. Limited liability company (LLC)
- In most cases, LLCs provide liability protection for all owners by law through “passing through” taxation and asset protection
- An LLC might be right for you if you want to take on active partners who would become personally liable for any legal liabilities faced by the partnership while running the business
4. S corporation (S Corp)
- The main advantage of an S Corp is that it allows companies to avoid double taxation by passing corporate taxes, losses, deductions, and credit through to shareholders for inclusion on their personal tax returns
- S Corporations are limited to 100 or fewer shareholders
5. C corporation (C Corp)
- In exchange for double taxation at the entity level (once as a business and second as stock dividends), corporations provide the liability protection of a corporation
- Examples include Apple Inc., General Electric, Ford Motor Co
6. Close corporation
A close corporation is a specific type of C Corporation that protects itself from outside investors by issuing shares only to a select few shareholders (typically family members and key employees).
Most states allow close corporations but each has its own requirements and rules
7. Benefit corporation
Sometimes known as “B Corp” or a “Low-Profit LLC” (L3C), this type of business is intended to produce a material positive impact on society and the environment as well as make a profit.
This business structure was created in response to the tax code’s emphasis on shareholder wealth maximization
8. Professional corporation
Any active partners in a GP must still be licensed professionals, although there are no limitations on non-licensed staff members who can participate in day-to-day decision-making for the company
A general partnership is a business model in which all owners are unconditionally responsible for its losses. This responsibility comes most prominently when the owners have created a formal written partnership agreement regarding sharing of profits and liabilities.
A general partner’s liability is unlimited, meaning that they are personally liable for any debts the business incurs.
We recommend consulting with legal counsel before forming any type of business entity because there can be severe tax consequences if done incorrectly.