Partnerships are the simplest type of legal structure to form for businesses with two or more principles; but while partnerships have no formal paperwork requirements, they usually don't protect partners from liability. Partners can also clash over numerous matters relating to the business, including conflicting work ethics and financial goals, and even roles in the business and leadership styles. Here you will find tips on legal and tax issues related to partnerships and a "Partnership QuickStart" tool that walks you through each phase of the start-up process.

Partnership Taxes

You may be surprised to learn that business partnerships do not have corporate tax status. What this means is that the Internal Revenue Service (IRS) doesn't have the power to tax them directly. Conversely, the government simply taxes the profits that flow to individual partners as personal income. When a business partner files his or her personal income tax return, he or she will need to declare their operating losses and profits to the IRS in Form 1065.

Buy Sell Agreements: Planning for the Future

Also referred to as "business continuation agreements" or "buyout agreements," a buy-sell agreement is a contract that provides for the possible future sale of your business interest or purchasing your co-owner's interest. One reason partners tend to enter into a buy-sell agreement is due to concerns about the health of one partner. If a co-partner dies, it will affect the operation of the business. A fully-funded buy-sell agreement can help eliminate any doubts about the future of your company.

Limited Partnerships: The Basics

There are three types of partnerships that businesses can choose from when forming a partnership: general, limited or joint venture. While there are benefits and disadvantages to all three, in a limited partnership at least one owner is a general partner and at least one owner is a limited partner. The general partner(s) makes everyday business decisions and becomes personally liable for any debts the business incurs. The limited partner, however, doesn't handle daily operations, but simply invests and reaps the benefits of any profits. Basically, a limited partner enjoys a protected investment.

Special Allocations

In a normal business arrangement, income, gains, losses, deductions, and credits are distributed according to each partner's or member's ownership percentage. However, when the partners set up a "special allocation," income and expenses are redistributed according to the allocation or agreement. Keep in mind, IRS rules must be followed if you want to divide profits and losses in a way that's disproportionate to the owners' interests in the business.

Hiring a Business Lawyer for your Partnership

Unfortunately, partnership rules and regulations can be extremely complicated. If you want to set up a special allocation, you'll need expert help to make sure that your allocation will comply with IRS rules. A business lawyer can draft special language for your partnership agreement or operating agreement to ensure that the IRS will accept your special allocation. An attorney specializing in partnerships can help you formulate your buy sell agreement and even help reduce your tax liability for the future.

A partnership arises whenever two or more people co-own a business and share in the profits and losses of the business. Other business legal structures include sole proprietorships, limited liability companies (LLCs), corporations, and nonprofit corporations.

In a partnership, each person contributes something to the business -- such as ideas, money, property, or some combination of these. Management rights, profit share, and personal liability will vary depending on which of the three modern partnership forms the business takes: general partnership, limited partnership, or limited liability partnership (LLP). Below are basic summaries of the main types of business partnerships.

General Partnerships

A general partnership involves two or more owners carrying out a business purpose. General partners share equal rights and responsibilities in connection with management of the business, and any individual partner can bind the entire group to a legal obligation. Each individual partner assumes full responsibility for all of the business's debts and obligations. Although such personal liability is daunting, it comes with a tax advantage: partnership profits are not taxed to the business, but pass through to the partners, who include the gains on their individual tax returns at a lower rate.

Limited Partnerships

A limited partnership allows each partner to restrict his or her personal liability to the amount of his or her business investment. Not every partner can benefit from this limitation -- at least one participant must accept general partnership status, exposing himself or herself to full personal liability for the business's debts and obligations. The general partner retains the right to control the business, while the limited partner(s) do(es) not participate in management decisions. Both general and limited partners benefit from business profits.

Limited Liability Partnerships (LLP)

Limited liability partnerships (LLP) retain the tax advantages of the general partnership form, but offer some personal liability protection to the participants. Individual partners in a limited liability partnership are not personally responsible for the wrongful acts of other partners, or for the debts or obligations of the business. Because the LLP form changes some of the fundamental aspects of the traditional partnership, some state tax authorities may subject a limited liability partnership to non-partnership tax rules. The Internal Revenue Service views these businesses as partnerships, however, and allows partners to use the pass through technique.

Existing partnerships that wish to take advantage of LLP status do not need to modify their existing partnership agreement, though they may choose to do so. In order to change status, a partnership simply files an application for registration as a limited liability partnership with the appropriate state agency. All states require disclosure of the partnership's name and principle place of business. Some states also require, among other things, identification of the number of partners, a brief description of the business, a statement that the partnership will maintain insurance, and written acknowledgment that the limited liability status may expire.