What are personally liable for the debts and obligations of the general partnership?
What are the major characteristics of a general partnership?A general partnership is the most basic form of business entity. The primary characteristics of the general partnership are as follows: Show
Back to: BUSINESS ENTITIES Back to: Entrepreneurship Forming a General Partnership - Creation & MaintenanceA general partnership is an agreement between two or more persons to share a common interest in a commercial endeavor and to share its profits and losses. There is no government-filing requirement to form a general partnership. The partnership can arise by default from the actions or activities of the partners. This general partnership definition contains similar elements to the sole proprietorship, but it requires more than one person.
The agreement between the individuals does not have to be written or expressed. It can be implied from the actions of the partners. It is important to understand that a general partnership is a default entity. That is, the partners do not have to intend to create a general partnership, nor do they have to realize that a general partnership has been formed.
Individuals may enter into a written agreement, known as a partnership agreement, establishing a general partnership. A partnership agreement is the governing document for any type of partnership. Partnership agreements are not mandatory, but it is advisable for any partnership to have an agreement governing the partnership relationship.
A general partnership has no formal maintenance requirements. There are, however, default rules that provide for the rights of partners with regard to the partnership. This may include the right to vote for certain partnership decisions and a right to profits of the partnership. These rules are a form of governance requirement that may be considered maintenance of the business entity.
What does it mean to be at-will partners?As previously noted, a general partnership may arise simply through an intent to undertake a mutual activity for a profit. That is, parties who do not intend to be partners may, nonetheless, be deemed a general partnership at-will. The at-will characteristic means that there is no formal agreement in place delineating the time during which the individuals will remain partners. Any partner may leave the partnership at any time. In determining whether the activity of individuals forms a partnership, a court will look at the totality of the circumstances. This means that the court will examine any evidence of the activity or relationship between the individuals to see if they meet the state law characteristics or requirements of a partnership. The circumstances may obviously indicate that some other type of relationship exists, such as an employer-employee relationship exists. In this case the individuals will avoid the classification of partners and all of the default rules and obligations that accompany such designation. Characteristics of an At-Will PartnershipWhat is the ownership of an At-Will Partnership?The default rule is that partners of an at-will partnership share equally in the ownership of the business. It does not matter if the partners contribute at different levels to the partnership, either through assets of labor. Who has authority in an At-will Partnership?The default is that each partner has the authority to take part in the management of the firm. Likewise, the partner has the inherent authority to act on behalf and bind the firm in agreements. Who has Decision Making Authority in an At-Will Partnership?The default rule allows partners to participate in management decisions. Generally, routine, operational decisions may be made by a majority of partners. Major decisions affecting the business must achieve the unanimous support of the partners. What is the Personal Liability of Owners of an At-Will Partnership?As in any general partnership, partners in an at-will arrangement have unlimited personal liability in tort for the actions of other partners. Likewise, the partners are personally liable for the debts or obligations of the partnership. This may include situations where other partners bind the partnership without the actual authority to do so. What are the Fiduciary Duties in an At-Will Partnership?Partners share a common fiduciary duty to act in the best interest of the partnership. At times, this duty has been construed as a duty to act in the best interest of other partners. The fiduciary duty is generally to avoid self-dealing and not an appropriate business opportunity for one's personal benefit or to the exclusion of other partners. What is a GP agreement and What Should it Include?A partnership agreement is the governing document for any type of partnership. Partnership agreements are not mandatory, but it is advisable for any partnership to have an agreement governing the partnership relationship. In the absence of a formal agreement, states have default rules governing the operations of the partnership and the relationship between the partners. While the default rules are comprehensive, they often do not always align with the specific intent of the parties.
A partnership agreement, like other business entity governance documents, should be drafted to address the specific concerns of the business and the partners. Below are some of the major considerations to address within any partnership agreement.
What is a buy-sell agreement and why is it important?A buy-sell agreement outlines the procedures for a partner leaving the GP. It can be included within the partnership agreement or it can be separate. Generally, it outlines the procedures for dissolving or continuing the business if a partner dissociates. It can outline procedures for both voluntary and mandatory dissociation. It will address the following issues:
What other steps should I follow in forming the GP?Undertaking business activity as a default GP is only part of the process in forming a GP. Other (optional or mandatory) considerations include: reserving and filing a business name with the state or local government (known as a Doing-Business-As filing), drafting a partnership agreement, obtaining a business license, registering for a federal EIN and state taxpayer identification number, and obtaining any federal, state or local permits or licenses.
What is the Continuity of the General Partnership?The duration of a partnership is determined by the intent of the parties. An at-will partnership has no stated date. The partnership will continue until the partners dissolve the business. The partners can designate a time period for the general partnership, after which the partnership dissolves. This is known as a term partnership. This means that the parties may have some duty to the partnership to remain partners for the pendency of the state time period. If the parties do not designate a specific purpose or time for the partnership's existence, it is considered an at-will partnership. This means that partners can dissociate from the partnership at any time.
How is a Partnership Terminated?In the absence of a written agreement, a partnership ends when a partner gives notice of his express will to leave (dissociate). When there's a written agreement, the partnership ends when an event outlined by the agreement occurs or when a majority of the partners decide to end the partnership after a single partner dissociates. Written agreements can be very useful in the termination of a partnership, because they can outline a process to be followed. For example, the partnership can allow the remaining partners to continue the business if they agree to do so. Whether there is a written agreement or not, it's fairly easy to leave a partnership, though you'll still be responsible for obligations that the partnership incurred while you were there. Terminating a partnership is more of a process than a single moment in time because there generally remains a business that needs to be wound down (i.e., debts to be paid, obligations to be fulfilled). Partnerships have the advantage of easily flowing profits into personal income and very easy formation, but also have the disadvantage of personal liability for business obligations. As a business owner, you'll have to weigh these factors and determine whether forming a partnership is right for you. Any partner in a partnership may dissociate at any time. This, and certain other actions by partners, may give rise to dissolution. Absent an agreement otherwise, the following activities generally give rise to dissolution of the partnership:
The continuity of the partnership is determined by the partnership agreement. If the partners do not have a partnership agreement stating otherwise, the partnership does not have continuity. That is, the default rule in many states is that a general partnership dissolves when a member dissociates. As such, a partnership interest cannot be transferred or passed along to one's heirs. Most states, however, allow the remaining partners to take steps to reform the general partnership and continue in business after cashing out the dissociating party's interest.
As stated above, partners can change the default rules governing the general partnership by entering into a partnership agreement. The agreement may also designate the procedures for winding down the business or allowing the remaining partners to continue the business. It can further allocate responsibility for debts of the general partnership or allocate the proceeds upon continuation or dissolution. These types of agreements are known as buy-sell agreements. Who Owns a General Partnership?General partners are the sole owners of the general partnership. The parties may agree on each partners percentage of ownership. In the absence of a partnership agreement, default partnership rules govern the relationship. By default, partners are entitled to equal ownership rights. This means that the partners share equally in profits or losses, unless the parties specifically agree to some other allocation of profits and losses. Further, the default rule is that ownership interests cannot be transferred to third parties without the consent of the existing partners. Attempting an unapproved transfer of an ownership interest is grounds for dissolution of the partnership.
Who has Control of a General Partnership?The general partners have complete control over the partnership. This means that partners have decision-making authority with regard to the governance and strategy of the partnership, as well as authority to act on behalf of the partnership as a general agent. The partners may establish a partnership agreement that changes or limits any partner's right of control or voice in the management of the partnership. This does not, however, limit the authority of a partner to obligate the partnership by entering into transactions or relationships with third parties, such as loan or sales agreements. The partnership can limit the authority of a partner to act on behalf of the partnership by specifically giving any third party notice that the partners authority is limited.
What are the partner's duties to the GP?Partners have default obligations to the GP. As an agent of the GP, these duties are fiduciary in nature. Specifically, a partner has duties of care and loyalty to the GP. The duty of care requires that the partner use reasonable care in carrying out GP business. The duty of loyalty requires that the partner act in the best interest of the GP. This means that the partner cannot usurp any personal benefit that is intended for the GP.
Of course, partners can change the default rules governing the GP by entering into a partnership agreement. For example, the partners can designate a time period for the GP, after which, the GP dissolves. The agreement may also designate the procedures for winding down the business or allowing the remaining partners to continue the business. It can further allocate responsibility for debts of the GP or allocate the proceeds upon dissolution.
What is the Personal Liability of Partners in the Partnership?A general partnership is similar to a sole proprietorship in that it does not offer the business owners any form of personal liability protection. Each partner is personally liable for any debts, obligations, or tortious conduct of the business. This means that, if the business stops operating or goes bankrupt, the owners are liable for the debts and obligations of the business. In fact, each partner can be held totally liable for the entire debt of the business. This is known as joint and several liability. Per the law of agency, the partnership is liable for the obligations established by its agents or their tortious conduct committed within the scope of employment. As such, each partner is potentially personally liable for the actions of partners and employees of the partnership. This may be true even if a partner or employee exceeds her authority under a partnership agreement or employment agreement. These facts alone make a general partnership a potentially risky entity form under which to carry on business.
How are Partners Compensated?General partners are compensated by receiving a draw of partnership funds (generally profits). This is known as the partner's distributive share. By default, this draw is often representative of the percentage of ownership of each partner. The partners may, however, enter into an agreement allocating the distribution of profits or losses differently from the ownership structure. That is, a partner may receive a percentage of partnership profits or losses that is greater than or less than her ownership percentage. This must be justified based upon an economic reality of the partnership, such as one partner spending more time working for the partnership.
What is a special allocation and how does it work?General partners are not entitled to a salary for services performed for the GP; rather, they receive a distribution or draw of GP proceeds. The default rule is that each partner has equal ownership in the GP and, therefore, shares equally in profits and losses. The parties may, however, allocate the distribution of profits or losses differently from the ownership structure. This must be done through specific provisions in the partnership agreement.
How is a Partnership Taxed?General partnerships are not taxable entities; rather, they are pass-through tax entities. The partnership will subtract expenses and other deductions from revenue to determine the annual profits or losses. Like a sole proprietorship, partners report their share of general partnership profits or losses on their personal income tax returns. The general partnership does, however, have to prepare a tax return. This return is known as an informational return and is filed on IRS Form 1065. The return outlines the revenues and expenses attributable to operations. It will also outline the percentage or amount of the profit or losses to which each party is entitled. The partnership is obligated to provide individual partners with a Form K-1 outlining that partners share of profits or losses. These amounts are then recorded on the owners individual tax return.
Discussion QuestionIs there ever a situation when carrying on business as a general partnership is a good idea? Hint: Think about situations where other business entities are the general partners. Practice Question: In a short paragraph, can you describe the primary attributes of a general partnership? What is each partner's tax basis?This is a complicated subject. Entities taxed as GPs have unique basis rules that differ from other entities. Individual partners must track their basis in individual assets within the business. If the assets are later sold by the GP for a gain or loss, then the partner contributing the assets to the business may be attributed income based upon his or her basis in the assets. In general, tax basis is the value of assets that a partner contributes to the GP; however, this too is an oversimplification. A partner's basis also includes other factors, such as any relief of liability on debt that is assumed by the GP or the amount of business debt for which the partner is personally liable. Remember, it is not necessary that the partner personally guarantee GP debt, as partners are personally liable for any debts of the business. Each partners basis increases by the product of her percentage ownership in the business multiplied by the amount of debt assumed by the GP. A full discussion of basis calculation for partners is beyond the scope of this text. We strongly advise that you consult a tax professional when making basis calculations for property contributed to a GP.
What happens if the Partner wishes to make a distribution when it is not profitable?If the GP is not profitable, it may still make a distribution of funds to partners. If the GP distributes an amount of funds to a partner that exceeds the annual profits of the business, then the partners basis is lowered by that amount. Remember, profits of a GP are counted as personal income to the partners. If the business does not have profits, the partner's distribution is treated as a return of invested capital. Any distribution that reduces a partner's basis below $0, results in taxable income to the partner.
What if the partners leave any of the profits in the business, rather than take them out as a distribution?If the partners decide not to distribute any portion of the GP profits, the percentage of business profits attributable to each partner is still taxable to her. As previously discussed, this is known as phantom income. The partners report their share of profits on their personal income tax returns, even if it is not actually distributed. The GP now has additional operating funds and the amount of retained funds allocable to a partner raises that partner's basis in the GP.
What happens if the Partnership suffers losses?Just like profits, losses pass through to partners and are reported on their personal income tax returns. Since each partner is considered to be actively involved in the GP, the owners can use the losses to offset active income earned from other sources. The losses cannot be used to offset passive income.
How is a Partnership Funded?This is a very complicated topic that draws upon one's knowledge of tax law.
The partners fund the partnership by contributing assets to the partnership. The value of the assets contributed to the partnership is in exchange for an ownership interest in the partnership. If partners contribute assets of equal value and ownership of the partnership is divided equally, then there is no tax issue. If, however, one partner contributes assets of greater value and the ownership interests are equal, then the partner contributing property of a lower value is treated as having received income from the partnership. The income attributed to this partner equals 1/2 of the difference between the value of the property contributed. This is a form of phantom income. A partner may have a basis (amount of money invested) in the property that is higher or lower than the actual value of the property contributed to the partnership. The partner does not generally recognize any income or losses when contributing this property to the partnership. The partnership, however, takes a basis in the property equal to that of the contributing partner. The situation gets very tricky when the partner receives some kind of value other than an ownership interest back from the partnership. This other value is known as boot. The situation is further complicated if the partnership later disposes of the property. There is a significant issue as to how the profits or losses are allocated for tax purposes. Related Topics
Academic ResearchWhat are personally liable for the debts and obligations of the partnership?In general partnerships, every partner remains personally liable for the debts and obligations of the partnership. The LP separates at least one general partner with unlimited personal liability from limited partners whose liability typically will not exceed their contribution to the partnership.
What are the liabilities of a general partnership?General Partnership Liability
In a general partnership, every partner has unlimited liability for the obligations of the business, including debts and taxes. This means if the partnership defaults on loan payments, then the personal assets of the general partners may be liquidated to repay the debt.
Who is responsible for the debts of a partnership?Liability for partnership debts
Partners are 'jointly and severally liable' for the firm's debts. This means that the firm's creditors can take action against any partner. Also, they can take action against more than one partner at the same time.
Who is personally liable for the liabilities of the limited partnership?One party (the general partner) has control over the assets and management responsibilities, but also are personally liable. The other party (limited partners) are generally investors whose personal liability is limited to their investment.
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