A partnership is an organization having two or more owners that functions as a trade or business. Partnerships are almost as easy to form as a sole proprietorship: it’s an association of two or more persons to carry on a business for profit. Like a sole proprietorship, in most states there are no formal procedures to form a partnership – no forms to fill out, no agreements to sign and no documents to file – though it’s certainly desirable from a business and legal perspective. In a general partnership, partners share, jointly and severally, in the liability for business obligations.
A limited partnership differs from a general partnership in that it is typically defined as a partnership formed by one or more general partners and one or more limited partners. General partners are treated in the same manner as “typical” partners: they have joint and several liability for the debts of the partnership and often exercise control over the partnership. In contrast, limited partners may have limited liability (this depends on state law and how much control those limited partners exercise).
For tax purposes, while a partnership does file a separate return (a federal form 1065), income and losses associated with the partnership pass through to the individual partners. Items of income or loss retain their character and are reported to each partner in proportion to their interest, as determined either by statute or partnership agreement. Each partner is then responsible for reporting that information on their individual tax returns.
Limited Liability Partnerships: LLPs
A Limited Liability Partnership (“LLP”) is a relatively new form of entity. An LLP is similar to a general partnership but while a general partnership can exist on an informal basis, an LLP must register with the state. The benefit of registration – a formal acknowledgement of the entity – is that the LLP takes on a form of limited liability similar to that of a corporation. Typically, that means that partners aren’t liable for the bad behavior of the other partners though the level of liability can vary from state to state. There is generally unlimited personal liability for contractual obligations of the partnership such as promissory notes and mortgages (again, this varies by state). For federal tax purposes, an LLP is treated as a pass-through entity, similar to a general partnership.