Partnership
A partnership is a type of business structure where two or more individuals or entities come together to carry on a business or trade. Each partner contributes something to the business – this could be money, property, labor, skill, or other assets. In return, each partner shares in the profits and losses of the business.
There are several types of partnerships, including:
- General Partnership (GP) : In a general partnership, all partners are involved in the operation of the business and have unlimited liability, meaning they are personally responsible for the debts of the business.
- Limited Partnership (LP): In a limited partnership, there are general partners and limited partners. General partners manage the business and have unlimited liability, while limited partners are investors who are not involved in managing the business and whose liability is limited to their investment.
- Limited Liability Partnership (LLP): This is a type of partnership where all partners have limited liability, meaning they are not personally responsible for the debts of the business. This is a common structure for professional services firms, like law firms or accounting firms.
The specifics of how a partnership operates and how profits and losses are shared are usually set out in a partnership agreement. Partnerships are governed by partnership laws, which can vary from one jurisdiction to another.
One key feature of partnerships is that they are “pass-through” entities for tax purposes – the partnership itself does not pay income tax. Instead, profits or losses are passed through to the partners, who report them on their individual tax returns. This can be advantageous, as it avoids the “double taxation” that can occur with corporations, where profits are taxed at the corporate level and then again when they are distributed to shareholders as dividends.
Example of a Partnership
Let’s imagine a scenario where two friends, Alice and Bob, decide to start a graphic design agency.
Alice is a skilled graphic designer, and Bob is an experienced marketer. They decide to form a partnership where Alice will handle the design work, and Bob will handle the marketing and client acquisition. They each contribute an equal amount of start-up capital to the business.
This is a general partnership, as both Alice and Bob are involved in the operation of the business and both have unlimited liability. They decide that they will share profits and losses equally, reflecting their equal contributions to the business.
Alice and Bob work out all the details of their partnership and put them in a partnership agreement. This includes things like how decisions will be made, how disputes will be resolved, and what will happen if one partner wants to leave the business.
Over the first year, their agency does well and earns a profit. As the partnership is a pass-through entity for tax purposes, it doesn’t pay taxes on this profit. Instead, the profit is divided between Alice and Bob, and they each report their share of the profit on their individual tax returns and pay tax accordingly.
This is a simple example of a partnership, but partnerships can be much more complex, with many partners, complex profit-sharing arrangements, and different classes of partners with different levels of liability and involvement in the business.
