Partnerships - 101
If you start a business in Florida with multiple people without any type of formal registration with the state, you may have created a Partnership. A partnership is the default business structure Florida Law classifies businesses among co-owners who have agreed to share in profits and losses but have not made an election as to what type of entity they wish to be for mostly tax purposes.
However, depending on the co-owner agreement (i.e., one person manages the business while the others are silent investors), the default to General Partnership may not be the most favorable to the owners or the partnership itself.
There are 3 types of Partnerships:
(1) A General Partnership,
(2) A Limited Partnership, and
(3) A Limited Liability Partnership.
Here is a breakdown of the differences between the forms of Partnerships co-owners may seek to officially form:
1. The General Partnership.
To form a General Partnership, two or more people agree to manage and operate a business and share in its profits and losses. The General Partnership is easy to begin, all you need to create the Partnership is an oral agreement, however it’s recommended to put it in writing, in a written partnership agreement. There is no requirement to file with the state to begin the business, unlike with limited or limited liability businesses. This makes it easier to begin the business and cheaper, because you are not required to pay the filing fee with the state.
Example: Jack and Jill want to open a taxi company. They both quit their jobs and have a conversation where they both state that they wish to start the taxi company. To make it feel more official, they write their agreement on a piece of paper, and sign the paper at the bottom. They do not need to file this agreement with the State, but if they ever intend to merge, acquire, or convert into a limited partnership they will need to register with the state and file the written partnership agreement.
One of the benefits of a General Partnership are the way taxes are paid. These businesses have pass-through taxation, which means that the profits from the business are not taxed at the company level. The profits are distributed to the partners, and they are taxed based on what they receive, leaving only one layer of tax. If there was double taxation (like in corporations) the company is taxed on its profits, and then the partners are taxed on what is distributed to them, as income.
Example: Jack and Jill’s business is prospering, and they are making large profits. When it is time to pay taxes, the profits are distributed to Jack and Jill, who are then taxed on their income.
Because of the ease of creating a General Partnership, there are risks involved. General Partnerships hold all partners personally liable for the actions of the company, the actions of the partners, and themselves. In other words, each general partner's personal assets are unprotected from lawsuits, bankruptcy, and other financial and legal issues. Hence, a General Partnership is not the most attractive way to do business because it leaves the partners so exposed.
Example: Jack and Jill’s business is dangerous and exposes them to liability because they are driving customers around in their cars day-and-night. One day, Jack gets into an accident, he is at fault, it's been a long day and he wasn't paying attention. There is a customer in the car. The customer is injured and sues Jack for negligence. The customer wins but there is not enough money in the company's bank account to cover the judgment, so the court attaches the personal assets of both Jack and Jill to make sure the judgment is satisfied. If this were a Limited Liability Partnership, then the customer would most likely only be able to recover damages from the partnership, and not from Jack or Jill personally.
The liability and expose created from the General Partnership makes this form of business unattractive.
2. Limited Partnership.
The Limited Partnership is a better entity choice than the general partnership if you plan to have investors, however, it may be more expensive and it requires more interaction with the State. It requires a filing of a Certificate of Limited Partnership with the State and an annual report to the State each year.
This type of Partnership requires one (or more) general partners, similar to the above, and one (or more) limited partners. The general partners work the same as in the General Partnership, they manage and operate the business, and are personally liable for the actions of the business and other partners. The limited partners, however, act more like silent investors, and must not participate in the management of the Limited Partnership. Limited partners are not personally liable for the actions of the general partners and so their personal assets are not reachable by creditors. However, if a limited partner takes actions that are allocated to general partners, they are opening up their own liability as to that action and possible even greater.
Example: Jack and Jill create a taxi business, with Jack being a general partner whose duties are to manage and operate the business, and Jill being the one with the money to buy the taxi cabs needed to start the business. Jill does not do anything for the company otherwise. While Jack was driving a customer to the airport, he crashed into the back of a VW bus, causing injury to his customer. The customer sues and is able to recover damages from Jack's personal assets, because he is a general partner, but cannot recover from Jill’s personal assets, because she is protected as a limited partner.
Limited Partnerships are taxed the same way as General Partnerships above.
3. Limited Liability Limited Partnership.
The Limited Liability Limited Partnership is similar to the General Partnership in that it has general and limited partners but in this type of entity, the General Partner is also protected personally. An exception to personal liability when the general partner personally guarantees a loan from a bank.
Limited Liability Limited Partnership are treated the same as General Partnerships for tax purposes. Additionally, limited partners do not have to return self-employment taxes due to not being operational in the business since the IRS considers limited partner's share as not "income earned".
If you are thinking about starting a business with someone else, consider consulting a business law attorney. The Law Office of Brown Huff Zohar is eager to hear your new business idea and strategize how to best protect your hard-earned assets.