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    Partnership FAQs - Answers to the Most Common Questions

    Partnership FAQs - Answers to the Most Common Questions

    Q. What is a partnership?

    A. A partnership is an unincorporated business that is owned and operated jointly by two or more parties. It is typically an ongoing long-term business operation, the end goal of which is to create profit for the partners.

    Q. What's the difference between a partnership and an incorporated entity, such as a corporation or limited liability company?

    A. The biggest difference is that a corporation has a legal existence separate from its owners, with the same legal rights and obligations as a natural person. A corporation can hold property and assets in its own name, it can sue and be sued, and it must file income tax returns. A partnership does not have this type of separate and distinct existence.

    Unlike a corporation, a partnership is not required by law to hold meetings, elect officers, or maintain a corporate minute book. Usually the partners will all participate in the management of the partnership and will share pro rata (according to their individual contributions) in the profits and losses, and assume equal responsibility for the partnership's liabilities.

    Shareholders of corporations and LLCs are not personally liable for the obligations of the corporation / company. By contrast, partners in a general partnership are all personally liable for its obligations and can be sued by the partnership's creditors.

    Q. What are the legal requirements for creating a partnership?

    A. If you go into business with someone else, you have automatically formed a partnership and are not required to file anything to "create" the partnership in the eyes of the law. That having been said, depending on where the business is located and what type of partnership you are forming (such as a limited partnership), there may be some forms that are required by local government authorities for business and/or tax purposes.

    Do your research to find out if you're required to submit any documentation to satisfy those requirements in your state, province or territory. It is beneficial for all parties that the details of how the partnership will be run are clearly set out in a written partnership agreement. If you don't have a written agreement, the partnership laws of your state, province or territory will govern the partnership. A written partnership agreement will remove any ambiguity as to the parties' rights and their responsibilities to each other and to the partnership, and can eliminate many sources of conflict before they arise.

    Q. How can a partner leave the partnership?

    A. This is another reason to have a formal agreement in place. All partners can then agree what will happen to the partnership if somebody wants to leave the partnership for any reason - whether by choice (retirement, change of circumstances, etc) or by necessity (illness, incapacity, bankruptcy, death). Every Partnership Agreement should contain buy-sell provisions to deal with these situations, in order to avoid loss of income, litigation, tax implications, and other negative consequences.

    Q. How is partnership income taxed?

    A. As discussed above, a partnership is not considered a separate entity in the way that a corporation is, so the partnership does not pay income taxes on its own behalf. Partnership profits and losses pass through to the partners, who must claim them on their own income tax returns. The partners then pay taxes on their share of profits or deduct their share of partnership losses, as appropriate. Nevertheless, partnerships are required to file certain forms with the taxing authority - this is true in both the United States and Canada.

    Q. What is the difference between a general partnership and a limited partnership?

    A. A general partnership is a partnership in which all the partners participate in managing the business. In a limited partnership, one or more general partners are responsible for running the business while the limited partners (of whom there may be many) are responsible for capitalizing the business. The limited partners have very little control over the day-to-day operations, but in return for giving up that control their liability for partnership debts and obligations is limited to the extent of their investment. Securities laws may apply to the sale or transfer of limited partnership interests. If you're considering setting up a limited partnership to attract investment capital, you should consult a lawyer.

    Q. What is the liability of the partners in a general partnership?

    A. Because a partnership has no legal status as a separate entity, the partners are personally liable for all of the partnership debts and obligations. Partners in a general partnership have the same degree of liability as the owner of a sole proprietorship. If one of the partners creates an obligation for the partnership, all of the partners are bound by it. Limiting the liability exposure of the partners can be encompassed in a written agreement, by stipulating that all or a majority of the partners must consent to enter into certain types of obligations or to incur debts over a certain limit on behalf of the partnership.

    Limited partnerships reduce the liability of the limited partners to the extent of their original investment. The general partner manages the partnership and accepts full liability for the partnership obligations, and the limited partners give up any management authority in return for the protection from liability.

    Q. What provisions should a Partnership Agreement include?

    A. A written Partnership Agreement should contain the following:

    • The identity of each partner.
    • The name of the partnership and the type of business it will operate.
    • The amount / extent of each partner's investment.
    • A procedure for allocating profits and losses.
    • The duties of each partner with respect to the partnership business.
    • The partners' privileges for drawing on the partnership accounts (if applicable).
    • Restrictions on an individual partner's ability to act on behalf of the partnership (and therefore the other partners).
    • What types of events will dissolve the partnership (death or incapacity of a partner, for example).
    • Procedure for terminating the partnership (for example, either partner may terminate the agreement and dissolve the partnership upon _____ days written notice to the other partner).
    • Procedure for removing a partner.
    • Procedure for dealing with the partnership interest of a deceased or departing partner.
    • Mechanism for dispute resolution.
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