What is a partnership and how do I create one?

A partnership is a business owned by two or more people that hasn't filed papers to become a corporation or a limited liability company (LLC). You don't have to complete any paperwork to create your partnership -- the arrangement begins as soon as you start a business with another person.

Although the law doesn't require it, many partners work out the details of how they will manage their business in a written partnership agreement. If you don't create a written agreement, the partnership laws of your state will govern your partnership.

Are there special rules for running partnerships?

Unlike corporations, partnerships are relatively informal business structures. Partnerships aren't required to hold meetings, prepare minutes, elect officers, or issue stock certificates. Generally, partners share equally in the management of the partnership and its profits and losses, and assume equal responsibility for its debts and liabilities. These and other details are typically described in a partnership agreement.

Is a written partnership agreement required for every partnership?

No law requires partners to create a written partnership agreement, but it's smart to do so. If you don't make a partnership agreement, you run the risk that the default rules in your state's partnership laws will govern your partnership in ways you and your partners won't like.

Creating a written partnership agreement will also give you and your partners a chance to discuss your expectations of each other, define how each of you will participate in the business, and help you work out any sticky issues before they become major problems.

You don't have to spend a fortune on lawyer's fees to create a valid agreement -- you and your partners can easily put together a simple, clear agreement yourselves.

How are partnerships taxed?

A partnership is not considered separate from its partners for tax purposes. Generally, this means the partnership itself does not pay any income taxes; instead, partnership income "passes through" the business to each partner, who then reports his or her share of business profits or losses on an individual federal tax return. Each partner will need to estimate the taxes he or she will owe at the end of the year and make four quarterly estimated tax payments to the IRS.

Are owners of a partnership personally liable for business debts?

Legally, a partnership is inseparable from its owners. As a result, each partner (with the exception of the limited partners in a limited partnership) is personally liable for the entire amount of any business-related obligations. This means that if you form a partnership, creditors can come after your personal assets (such as your house or car) to make sure any partnership debts get paid.

In addition, you are legally bound to any business transactions made by you or any of your partners, and you can be held personally liable for those actions. For example, if your partner takes out an ill-advised high interest loan on behalf of the partnership, you can be held personally responsible for the debt.

In contrast, owners of limited liability companies (LLCs) and corporations are not personally liable for business debts. For more information about limited liability, see LLC Basics and Corporation Basics.