A partnership is a form of business organization in which owners have unlimited personal liability for the actions of the business. The owners of a partnership have invested their own funds and time in the business, and share proportionally in any profits earned by it. There may also be limited partners in the business, who contribute funds but do not take part in day-to-day operations.
A limited partner is only liable for the amount of funds he or she invested in the business; once those funds are paid out, the limited partner has no additional liability in relation to the activities of the partnership. If there are limited partners, there must also be a designated general partner that is an active manager of the business; this individual has essentially the same liabilities as a sole proprietor.
The key advantages of a partnership are as follows:
- Source of capital. With many partners, a business has a much richer source of capital than would be the case for a sole proprietorship.
- Specialization. If there is more than one general partner, it is possible for multiple people with diverse skill sets to run a business, which can enhance its overall performance.
- Minimal tax filings. The Form 1065 that a partnership must file is not a complicated tax filing.
- No double taxation. There is no double taxation, as can be the case in a corporation. Instead, earnings flow straight to the owners.
The disadvantages of a partnership are as follows:
- Unlimited liability. The general partners have unlimited personal liability for the obligations of the partnership, as was the case with a sole proprietorship. This is a joint and several liability, which means that creditors can pursue a single general partner for the obligations of the entire business.
- Self-employment taxes. A partner’s share of the ordinary income reported on a Schedule K-1 is subject to the self-employment tax. This is a 15.3% tax (social security and Medicare) on all earnings generated by the business that are not exempt from these taxes.