Though the news is filled with stories of small businesses closing their doors during the pandemic, small business applications are rising at the fastest rate since 2007. Recently, the Wall Street Journal reported that “applications for employer identification numbers have passed 3.2 million so far this year, compared with 2.7 million at the same point in 2019.”
When setting up a business, you need to decide what type of business entity you’d like to form. Previously, we discussed a Sole Proprietorship (link to that article). Another type of business entity is a General Partnership. Rules vary by state, so for the purposes of this article, we are discussing setting up a General Partnership in New York State.
What is a General Partnership?
A General Partnership is an arrangement between two or more persons to carry on unincorporated business together for the purpose of profit. In absence of a partnership agreement, partners in a general partnership share equal management responsibilities, assets, liabilities, profits, and losses of the partnership; and a general partnership dissolves when one of the partner passes away, becomes disabled, or leaves the partnership.
Is a Partnership Agreement Necessary?
There is no requirement to have a partnership agreement to form a general partnership. A general partnership can be formed if two or more persons are acting or implying to the public that they are running a business for profit together. However, if you and your partner(s) have an intention of doing business together, it is better to have a written partnership agreement, so that the overall structure of the business, each owner’s rights and responsibilities including voting rights and division of profits are in writing to avoid possible issues in future operations.
Having a partnership agreement gives partners more flexibility, such as unequal division of profits and losses. It also details partnership dissolving events other than a partner leaving, and sets up options for remaining partners when dissolving events occur so that the partnership can continue. If you want to set up a general partnership officially, you’ll need to create a partnership agreement, file a Certificate of Assumed Name with the county clerk’s office in the county where the partnership conducts business and obtain an Employer Identification Number (EIN). Depending on the type and location of your business, you may need to obtain business licenses and permits.
The Advantages and Disadvantages of a General Partnership
Running a business with other person(s) as a General Partnership provides advantages such as additional funding, knowledge, skills, more business opportunities, and even mental support. However, there are disadvantages. The biggest disadvantage of having a general partnership is the share of partnership liabilities. Each partner in a general partnership has unlimited personal liability for the partnership debts and obligations. For example, if the partnership cannot pay creditors or in case of bankruptcy, the creditors can go after each partner’s personal assets. Partners in a general partnership are also jointly and severally liable for the actions of other partnership liabilities such as torts, breach of contracts and trusts. This means that if one of the partners gets sued by a third party, the other partner(s) is also individually liable for the full extent of the damages. Therefore, we recommend choosing your partners very carefully.
What Tax Forms Does a General Partnership File?
The profits and losses earned by the partnership will pass-though to the partners. The Partnership will file Form 1065 on the Federal level, which is an information return, so there is no income tax imposed at the partnership level. Each partner will receive Form 1065 Schedule K-1, which contains each partner’s share of activities for the taxable year. Each partner then reports the information on the Schedule K-1 on his or her Form 1040 and pays taxes at each partner’s individual income tax rate. The ordinary income passed-through from a general partnership is usually treated as self-employment income hence subject to FICA taxes, which is similar to social security and Medicare taxes for wage earners.
You will be required to file state tax returns in the state you are doing business. In New York State, the partnership will file a Form IT-204, which is again an information return. Each partner receives Form IT-204 IP, which shows each partner’s share of income and losses reported on the Federal information return as well as income and losses that are apportioned to New York for NYS non-resident partners. The Form IT-204 IP also provide partners’ New York adjustments to Federal amounts due to the decoupling from Federal law by NYS and some other state additions and subtractions that are required by NYS. Partners then report appropriate information on Form IT-204 IP on their NYS individual income tax return, such as NYS Form IT-201 for NYS residents. Also, IT-204 IP lists the partner’s share of income earned in the Metropolitan Commuter Transportation District (MCTD) that is subject to the .34% Metropolitan Commuter Transportation Mobility Tax (MCTMT). In addition, if the partnership has income and losses from other states, non resident K-1s will be prepared for those states.
If you have any questions about whether a General Partnership is the right entity for your business or about the requirements, please contact us. Owning a business can be incredibly rewarding, especially when you set it up properly in the beginning. Here’s to your success!