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Ultimate Guide To Partnerships
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Ultimate Guide To Partnerships
Creating and running a viable business is not a one-person job. It takes dedicated people with a variety of skill sets, each bringing their unique capabilities to the table. The basic structure of a business needs different departments that work together to deliver on the short-term and long-term goals of the company.
These departments can be operations, marketing, product department, purchases or sales. But what brings them all together is partnership.
The Internal Revenue System (IRS) recognizes partnerships as a legal business incorporation structure. In some partnerships, the individuals share the responsibilities and liability, but there are many variations on this model.
Table of contents
What are partnerships?...Read more
How to set up a partnership?...Read more
What are the different kinds of partnerships?...Read more
Taxes and partnerships...Read more
What's a Schedule K-1?undefined...Read more
What's Form 1065?...Read more
What are the advantages and disadvantages of partnerships?...Read more
What are partnerships?
Partnerships are business entities formed when two or more individuals join together to work on the same business objective. Business partnerships are teams formed after an agreement on a certain set of rules in a formal agreement. In a partnership, the individuals mentioned in the agreement share profits and liabilities based on the individual contract terms.
The goal of a business partnership is to divide responsibilities, profits and liability among partners equally or based on the stakes of each partner. Partnerships are simply agreements between two or more individuals, and after sole proprietorship, they are the simplest form of a business entity defined under U.S. law.
How to set up a partnership?
To set up a partnership, you first need to put a team of partners together after assessing each member for their skills and individual contributions. You also need to decide what kind of partnership you want to establish with them.
Then you need to decide on a name, check if it's legally available and register the partnership with the state where you're incorporating your company. Each state has its own rules and regulations around this.
What are the different kinds of partnerships?
There are four kinds of partnerships in the U.S.: limited liability partnerships, limited partnerships, general partnerships and LLC partnerships.
Each fits the different needs of the individuals forming the partnerships. A limited liability partnership (LLP) has limited liability for all the partners, which means that if the situation with the business tends to go south, the partners have protection against debts. Each owner in the partnership has a predefined set of liabilities and is not responsible for any hardships arising from the actions of other partners.
Limited partnerships involve one or more general partners responsible for unlimited liability. A partnership suits entrepreneurs who own the brand but share key responsibilities with other partners. Apart from general partners, all the other partners have limited liabilities. It's often the case that the founder(s) of the company invites other partners to join the company and offers limited partnership as a motivating factor. The partner(s) with unlimited liability also has to file self-employment taxes.
You might be wondering – what's a general partnership? In a general partnership, the partners share all profits, responsibilities, losses, debts and lawsuits equally. In addition, the agreement that binds the partners together ensures equal ownership rights to all the owners involved. In this case, the name of the business is often the name of the partners.
Last but not least, an LLC or limited liability company is like a hybrid of a partnership and business structure. It combines aspects of partnership and an extensive business corporation. If you are a partner in an LLC, your personal possessions – house, car, bank account – have protection against bankruptcy and any losses the company faces.
Taxes and partnerships
One of the most attractive reasons for setting up a partnership is the tax factor that's in place. Unlike self-employed individuals, a partnership allows you to "pass-through" the income of the business to the partners. The income from the company is split between the partners, and so is the tax bill. Essentially, partnerships do not pay taxes; its partners do. Partnership taxes are filed using Schedule K-1.
What's a Schedule K-1?
The Schedule K-1 form is used to report the income of the partners in the business, SCorps and other business entities. Schedule K-1 helps the entity track each partner's individual earnings. The K-1 form is quite similar to 1099, the only difference being that the latter serves self-employed individuals and freelancers.
The individual agreements of the partnerships influence the information on Schedule K-1. For example, the general partners in the contract are responsible for all the other partners with limited liability. The general partners are responsible for reporting individual income using Schedule K-1.
The form includes details about individual profits, losses, credit information, investment details and other distribution of wealth and assets generated by the partnership. Apart from partnerships, the K-1 form is also used to calculate tax returns for S-Corp.
The K-1 includes details about each partner, like their investments in the business, shares and income. The idea is to calculate a partner's stake in the company, or basis. So your basis (stake) as a partner is decided based on your contributions and profits.
Alternatively, if you have incurred losses in a partnership, they will reduce your basis in a partnership. If you are making a certain percentage of profit, that will be counted as your basis in the partnership. If your profit increases, your basis also increases.
It's important to note that Schedule K-1 collects information from the partners and reports it to the IRS. The K-1 form is sent to the IRS and is attached to the 1065 form.
What's Form 1065?
The IRS form 1065 is used to report your profits, losses and income from partnerships. 1065 goes to the IRS, and you must also attach a copy with your usual 1040 filing.
So the final income tax will depend on your income calculated by adding the income from partnerships in the 1065 and the income from other activities 1040 form.
What are the advantages and disadvantages of partnerships?
The advantages and disadvantages depend on the type of business partnership. Contributors' roles are governed by individual agreements. Based on the need, one kind of partnership can have an advantage or disadvantage.
Partnership advantages:
- You can have multiple partners with different skill sets.
- Risk is divided between partners, and you can limit your losses and liabilities.
- The company has a more considerable working capital with numerous partners.
- Greater tax saving as you can split the profits.
- As a partner, you can still keep your income from other sources private.
- The disadvantages depend on the type of partnership.
- You are bound to the legal terms and the agreement of the partnership.
- In a general partnership, the liabilities are equally divided between the partners.
- If you have unlimited liability in partnership, the bulk of the liability and debt burden lies on your shoulders.
- In a general partnership, the actions of other partners impact every partner equally. So with two or more partners in a general partnership, each one will be equally liable if one partner defaults.
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