Free Partnership Worksheet

One disadvantage of a partnership is that its existence is contingent upon the continued ownership by all the partners. For example, if an owner withdraws from the partnership or dies, the partnership would terminate, unless the remaining partners consent to the continuation of the business. Such unanimous consent may be difficult to obtain.

Partners may wish to provide that the remaining partners will purchase the withdrawing partner's share or buy back a deceased partner's share from the deceased partner's estate. Or, a partnership agreement might provide a simplified procedure for securing the remaining partners' consent to the continued existence of the business despite one partner's death or withdrawal.

An Employer Identification Number (EIN) is a nine-digit number (for example, 12-3456789) assigned to partnerships and other entities for federal tax filing and reporting purposes. The partnership should obtain an EIN for several reasons:

1. A bank or other lending institution will require the EIN before loaning the business money or setting up a business checking account;

2. The EIN will be needed for filing the partnership income tax return forms, as well as other required tax returns.

Under new "check the box" regulations, LLCs consisting of two or more members will be automatically taxed as partnerships unless they affirmatively elect to be taxed as a corporation. Single-owner LLCs will be taxed as a sole proprietorship unless they affirmatively elect to be treated as a corporation. In other words, for federal taxation classification purposes, the old four-factor test is no longer relevant. LLCs can enjoy partnership, or sole proprietorship, "pass through" taxation of income even though they may be organized to have:

1. unlimited life,
   
2. centralized management,
   
3. limited liability, and
   
4. free transferability of interests.

A partnership is usually limited in its ability to deduct the costs of fringe benefits provided to its employees. Most partnerships can deduct only the cost of benefits provided to non-owner employees.

In contrast for example, regular corporations (those that have not selected Subchapter "S" tax status) can generally deduct the entire cost of group health plans, pension plans and limited amounts of life insurance, even for owners/employees, provided that certain tax regulations are followed which discourage plans that primarily benefit highly compensated employees. However, such corporations are also subject to double taxation of business profits; once at the corporate level and again when those profits are distributed as dividends to the owners.

A general partnership is like a sole proprietorship except that it is owned and managed by more than one owner.

1. Organizational Formalities. Generally, organizational formalities are not required by law to form a partnership, but often the partners adopt a partnership agreement that explains how the partnership will be operated and governed.

2. Personal Liability of Partners. Similar to a sole proprietorship, each partner is personally liable for all of the debts and expenses of the business, that is each partner's liability is "unlimited." Further, each partner is liable for the acts of the other partners.

3. Income Taxation. The income and expenses of a partnership must be reported on a separate tax return (Form 1065). The net income of the partnership is then allocated to the partners, and the individual partners report their respective shares of the income on their individual income tax returns.

4. Taxation of Fringe Benefits. A partnership may have more flexibility in deducting the costs of providing fringe benefits to employees than a sole proprietorship, but the costs of such benefits provided for the partners themselves may not be deductible.

5. Use of a General Partnership. The partnership form of business is most often used for small businesses whose owners want to avoid the tax consequences that result from corporate ownership and are willing to accept personal liability. One of the main drawbacks of the general partnership is that the partnership is dissolved or liquidated whenever a general partner ceases to be a partner for any reason, unless the remaining partners agree to continue the business, which consent is often difficult to obtain.

Most partnerships consist entirely of general partners who all have the right to participate in the management of the partnership, including day-to-day decisions of the business. However, a general partner is also personally liable for the debts and expenses of the partnership, including the partnership actions of the other partners.

In contrast, limited partners share in the profits and losses of the business, but are not permitted to have any management responsibilities. In return, their liability is limited to their respective capital contributions. A limited partnership may be appropriate for specific projects, for example, in which a developer (the general partner) with technical and management expertise, wishes to attract investors (limited partners) who do not want to risk personal liability and are comfortable with the concept of no participation in management.

A general partnership is not required to file of any documentation with the office of the Secretary of the State in which the partnership is doing business. However, a limited partnership must file a certificate of limited partnership. This is similar to the requirement that a corporation file articles of incorporation. The requirements of the certificate are specific and cover many of the issues that would otherwise be included in a general partnership agreement. Requirements vary by state, and it is advisable that you consult with an attorney regarding this issue.

The LLC is a form of business entity which represents a second attempt (in addition to the "S" corporation) to combine the "limited liability" feature of the corporation with the tax advantages of the partnership. LLCs are a relatively new form of business entity. Wyoming enacted the first LLC statute in 1977 and, as of this writing, LLC statutes are in effect in all fifty states.

1. Organizational Formalities. The formation of an LLC is similar to the formation of a business corporation � by filing Articles of Organization with the Secretary of State. The Articles must include basic information regarding (1) the name and address of the LLC and its registered agent, and (2) its period of duration, for example, 10 to 35 years, although most states now permit perpetual duration.

   The Articles can also include provisions regarding (A) the management of the LLC by all members (the owners) or certain persons (who can, but need not be members), known as "managers," a term similar to corporate directors, (B) limited liability of its members and managers, and (C) whether less than a unanimous vote of the members is required to dissolve, sell or merge the LLC or amend its governing documents (Articles of Organization and Operating Agreement). Some states still have statutes requiring an LLC to have two or more persons as members at the time that it is formed, but most states now allow single-member LLCs.

2. Operating Agreement. The LLC must also adopt an Operating Agreement that describes the rights and obligations of the members and how the LLC will be operated. The Operating Agreement is similar to a partnership agreement and somewhat similar to corporate bylaws.

3. Federal Tax Employer Identification Number. A federal tax Employer Identification Number should be obtained, as well as possible permits and licenses, depending upon the activities of the LLC.

4. Limited Liability. Similar to a corporation, the owners ("members") of an LLC have "limited liability."

5. Income Taxation. The LLC is usually structured to avoid corporate taxation. For LLCs formed prior to January 1, 1997, it was necessary to carefully structure the LLC to avoid the characterization by the Internal Revenue Service that the LLC was so similar to a corporation that it should be taxed as a corporation. These objectives may still be important for purposes of state income taxation. However, effective January 1, 1997, the Internal Revenue Service adopted new regulations which, for federal income tax purposes at least, abandons the old "four-factor" test and allows most LLCs to be taxed like a partnership or a Subchapter S Corporation. See Satisfying the Four-Factor Test (Pre-1997) and Federal Taxation for LLCs Formed After January 1, 1997

6. Use of LLCs. The LLC form of business entity is used primarily by small businesses that want:
   1. the limited liability protection of a corporation;

   2. the flexibility of organization and tax benefits of a partnership;

   3. the ability of the members to take part in the management of the business, unlike the prohibition that applies to limited partners in a limited partnership and the cumbersome three-tiered management structure of shareholders, directors and officers of a corporation;

   4. the protection to members afforded by many state statutes that disallow the transfer of any member's management rights in the LLC (versus "financial rights" which can often be transferred without restriction) without the consent of the non-transferring members; and

   5. freedom from the "S" corporation eligibility requirements. Although there are a few uncertainties involved with the formation of an LLC because it is a relatively new form of entity, there is an increasing trend toward the use of LLCs for small businesses, particularly service-oriented businesses.

A further variation of the general partnership is the LLP. The specific provisions of the LLP depend upon state law, but generally a partner in an LLP is not liable for the obligations of the partnership arising from the negligence, wrongful acts, or misconduct of another partner. However, each partner remains liable for the general contractual and commercial obligations of the partnership and for his or her own acts. The LLP entity is popular primarily with multi-state accounting firms.

The limited partnership is a variation of the general partnership, designed to cure the "unlimited liability" disadvantage. A limited partnership has one or more of both "general" and "limited" partners. The general partner is responsible for the management of the partnership, receives a share of the partnership profits and losses, and is personally liable for the debts. The limited partners share in the profits and losses but are not permitted to have any management responsibilities. In return, their liability is limited to their investment in the partnership.

The limited partnership form of business is most often used for specific projects, for which a developer (the general partner with technical and management expertise) wishes to attract investors (limited partners) who do not want the risk of personal liability and are comfortable in allowing someone else to manage the project.

A limited partnership name must include an indication that the entity is a limited partnership so that parties who deal with the company are aware of its status. Therefore, the name must include either the words "Limited Partnership" or the abbreviation "L.P."

A second requirement is that the name chosen must be distinguishable from any other limited liability company, limited partnership or corporate name which is already on file in that state, including names that have been temporarily reserved by persons intending to use that name. Whether a name is distinguishable lies within the discretion of the Secretary of State. For example, "Acme, L.P." is not sufficiently distinguishable from "Acme L.P." However, the Secretary may allow names that sound identical, but have different spellings.

A general partnership is not required to register its name with the Secretary of State and does not have to indicate its status. However, care should be taken to pick a name distinguishable from pre-existing businesses to avoid confusion and possible disputes over trade name rights another party may claim to a specific name.

A partnership agreement may include a non-compete provision limiting the freedom of a withdrawing partner to work for a competitor of the partnership or to start a new business that competes with the partnership.

The non-compete provision is intended to provide additional protection against the possibility that the knowledge gained by a withdrawing partner about the business will be used to compete against the partnership.

However, the courts in many states view non-compete provisions as "restraints of trade," and therefore are reluctant to enforce them. Some states have significant restrictions on the enforceability of non-compete provisions. Therefore, it is advisable to consult a lawyer to determine to what extent a non-compete provision may be enforceable in your state.

Non-compete provisions are enforceable in many states only when they are reasonable in terms of their effect on the parties and the public, and the restraint imposed is not greater than necessary to protect a company's valid business interest.

The following guidelines are often used by courts in determining whether non-compete provisions are "reasonable," and therefore, enforceable. The "time period" should be reasonable, limited to the useful life of the information possessed by the withdrawing partner. In many cases, this will be two to five years, but could be as short as one year, depending on how rapidly the information becomes obsolete. The "geographical area" in which competition is prohibited should be limited to the specific geographical area within which the withdrawing partner actually operated or for which the withdrawing partner had substantial information. A determination of reasonableness may depend on the specific facts of each situation.

Organizational formalities include items such as articles of incorporation, organizational minutes (or Consent), bylaws, stock certificates, federal employer identification numbers, and minutes and annual reports.

1. Articles of Incorporation. The corporation is formed by filing Articles of Incorporation with the Secretary of State. The Articles must include basic information regarding the names and addresses of the corporation, the registered agent, and the incorporator, as well as the number of authorized shares of stock. In addition, the Articles can include provisions regarding limited liability of the directors, preemptive stock rights, staggered directors' terms, and any unusual shareholder meeting requirements.

2. Organizational Minutes (or Consent). A corporation is also required to hold an organizational meeting to elect initial directors (unless already named in the Articles of Incorporation), elect officers, adopt Bylaws and take care of other organizational matters. These organizational activities can be handled instead by a written "organizational consent" signed by the incorporator(s) or the initial directors, unless such a method is prohibited in the Articles.

3. Bylaws. In addition to Articles of Incorporation, a corporation must have a set of Bylaws which define how the business and affairs of the corporation will be managed and regulated. Typically, a set of Bylaws includes provisions regarding shareholders meetings and voting, and the duties, qualification, election, terms and meetings of the directors. The Bylaws (or the Articles) may also include provisions regarding stock transfer restrictions, the execution of written instruments, higher-than-majority quorum requirements for directors meetings, and indemnification of directors.

4. Stock Certificates. A corporation may choose to issue stock certificates as evidence of the ownership by the shareholders of their respective interests in the corporation. However, physical certificates are not always required.

5. Federal Employer Identification number (EIN). An EIN must be obtained using Internal Revenue Service tax form "SS-4." Other forms, applications and licenses may be required, depending on the activities of the corporation. For example, there may be a need to register as a contractor, or the need to obtain a sales tax permit.

6. Minutes/Annual Reports. After formation, the corporation must observe certain formalities in order to preserve its separate legal status. Minutes or other records of shareholder and director action must be prepared at least annually. Additionally, annual reports generally must be filed with the Secretary of State.

The affairs of a partnership will be controlled by the state law in which the partnership is located. Unless the partners elect to alter the general rules, these "default" provisions will govern such important issues as voting rights, duration of the partnership's existence and transferability of each partner's ownership interest. Often, the partners may wish to alter the default rules to customize the relationship to suit that of the partners' desires. This can be accomplished by a written document called a partnership agreement.

Although partnership agreements vary widely in complexity, all of the following can be addressed in such an agreement:

1. the names of the partnership and partners;
   
2. the purpose of the partnership;
   
3. the duration of the partnership;
   
4. the amounts of capital contributed by the partners, and how additional capital will be raised, if needed;
   
5. how profits and losses will be divided;
   
6. what level of approval (e.g., majority? unanimous?) is required for management decisions;
   
7. a procedure for meetings of the partners;
   
8. a designated tax partner for income tax matters;
   
9. who will have authority to sign documents on behalf of the partnership;
   
10. how capital withdrawals may be made by the partners;
    
11. compensation (e.g., wages, vacations, fringe benefits to be paid to partners for services provided for the benefit of the partnership);
    
12. the right of partners to inspect the records;
    
13. procedures to handle the death, disability, or withdrawal of a partner; and
    
14. procedures to handle the dissolution of the partnership.

There are several types of business entities which can be formed. We recommend that you read Types of Business Entities before completing the Partnership Worksheet. Also, the Business Entity Planning Worksheet included in this program may be helpful in determining the type of entity that is most appropriate for a particular business. If you determine that a partnership is the proper type of entity for you, you can use this Partnership Worksheet to organize the information a lawyer or other advisor will need to prepare the documents necessary to form the partnership.

This Worksheet can serve as an educational tool as well as help to organize the relevant information. It allows you to provide information about each owner including whether an owner will be a general or limited partner, and explain the nature of the business, how profits and losses of the business will be divided, whether the partnership will continue after the withdrawal or death of the partner, and how the partnership will be managed. This information will assist an attorney or similar advisor in preparing a partnership agreement that describes how key elements of the business will be handled.

State laws for partnerships provide "default" rules that apply, if certain issues are not addressed in the partnership agreement. For example, most states provide that a partnership terminates upon the death of a partner. If the partners want the partnership to continue after the death of a partner, they should include a specific provision in their partnership agreement that explains what should happen if a partner dies.

A partnership agreement is a document signed by each partner that sets forth the intentions of the partners regarding various important issues, which may include the distribution of profits, the procedures for handling the death or withdrawal of a partner, or other matters. An attorney or similar advisor should be consulted to assist in preparing the partnership agreement.

Usually, a partnership has just one name (a "legal" name) that is used for all purposes. However, sometimes a partnership uses one name for legal purposes, including tax purposes, but uses another name (a "trade" name) for conducting its business with the public. For example, "ABC Partnership" doing business as "Joe's Bar and Grill".

Professional corporations are a variation of the basic corporate form which are used by professionals -- persons who are required to obtain a license from the state in order to practice their profession, for example, physicians and lawyers. A shareholder in a professional corporation must be a licensed professional in the same profession, and continues to be personally liable for his or her own professional conduct. But the professionals do receive liability protection with respect to the professional conduct of the other shareholders.

In order to avoid structuring an organization which is deemed to be a corporation for income tax purposes, the LLC must have no more than two of the four characteristics that define a corporation: (1) limited liability, (2) continuity of life, (3) centralization of management, and (4) free transferability of ownership.

Limited Liability. The members of the LLC have "limited liability" for the debts and expenses of the LLC. Because this characteristic is a given, the LLC is allowed to have only one of the other three characteristics. In fact, state LLC statutes usually try to allow the owners (members) to avoid all of the other three characteristics.

Continuity of Life. "Continuity of life" is the continuation of the business entity without regard to the death of the owners. To purposefully violate this characteristic, the duration of the LLC cannot be perpetual.

Centralization of Management. A corporation has "centralization of management" because of its management through a board of directors. This corporate characteristic can be avoided by giving all LLC members the right to be involved in the management of the LLC. However, if the owners of an LLC choose to establish "managers," the LLC can still avoid tax status as a corporation by avoiding two of the other three corporate characteristics.

Fee Transferability of Ownership. Generally, the owners of a corporation can "freely transfer their ownership" in the corporation by selling their shares of stock. To avoid this corporate characteristic, the LLC can impose transfer restrictions, for example, that a member may not transfer his/her shares without the consent of all of the other members.

1. The Partnership Worksheet is not a legal document and does not require any signatures, witnesses or notarization.

2. The Worksheet is not intended to serve as a partnership agreement, but it is an educational tool which can be used to organize the information needed by a professional advisor to form a partnership.

A sole proprietorship is an unincorporated business owned and managed entirely by the "proprietor," except to the extent that the proprietor may delegate management responsibilities to an employee. It is the simplest form of business. However, simplicity may be the only advantage of the sole proprietorship.

1. Organizational Formalities. There are no organizational formalities required and generally no other agreements necessary. However, if the business will have employees, a federal Employer Identification Number will be required. A sales tax permit and/or licenses may be required.

2. Liability of Owner. The owner is personally liable for all of the debts and expenses of the business, that is, the owner's liability is "unlimited." If the business is unable to pay its obligations, the non-business assets of the owner will be at risk unless protected by an exemption (for example, the homestead exemption for the owner's personal residence). Some protection can be obtained through liability insurance.

3. Taxation. The income and expenses of the sole proprietorship are reported as part of the owner's individual income tax return. There is no extra tax return to be prepared each year. Every other form of business entity requires a separate tax return for the business (except an LLC taxed as a sole proprietorship).

4. Taxation of Fringe Benefits. A sole proprietorship generally has less flexibility to deduct the costs of fringe benefits, which means fewer after-tax dollars.

5. Use of the Sole Proprietorship. The sole proprietorship form of business is most often used for small, low-risk businesses that have only a few employees and no need for more than one owner.

Both business corporations and professional corporations can make a special "S" corporate election that alters how the income of the business is taxed. After forming a corporation, the shareholders elect "S" status for tax purposes under Subchapter S of the Internal Revenue Code by filing Form 2553 with the Internal Revenue Service on or before two months and 15 days after the beginning of the taxable year in which it is to be effective.

The income and expenses of an "S" corporation are reported on a separate tax return (Form 1120S), but like a partnership, the net income of the "S" corporation is then allocated to the shareholders who report their respective shares of the income on their individual income tax returns. Therefore, the "S" corporation combines the "limited liability" feature of the regular corporation with the tax advantages of the partnership.

A disadvantage of the "S" corporation is the number of technical tax rules. For example, the following rules (among others) apply:

1. Number of Shareholders. An "S" corporation may not have more than 75 shareholders.

2. One Class of Stock. An "S" corporation may only have one class of stock.

3. Calendar Year-end. Generally, the corporation must use a tax year that ends on December 31 of each year, unless the corporation can show that it has a "peak period" of business that ends other than shortly before December 31.

4. Fringe Benefits. Some types of fringe benefits (for example, health insurance benefits) are not deductible for shareholders who own more than 2% of the corporation.

This information is important to assure that tax related materials and issues are directed to the partner who can handle them most efficiently. Furthermore, it may be necessary to provide this information to the Internal Revenue Service as a contact person for tax matters.

A partnership must have a tax year that is identical to that of its partners. Usually, this will require the partnership to operate with a calendar year end, although there are some very limited exceptions.

The income and expenses of a partnership must be reported on a separate tax return (Form 1065). The net income of the partnership is then allocated to the individual partners, and each partner reports their respective shares of the income on their individual tax returns (Form 1040).

Although two forms are required, a partnership is only taxed once. The partnership return (Form 1065) is merely for reporting purposes. The actual tax will be collected and paid by each partner individually.

For more information regarding the various tax issues related to a business entity, it is advisable to consult with a tax expert.

A potential problem for any business with more than one owner is whether each owner will have the unrestricted ability to transfer/sell his or her shares to anyone he or she wishes. Many small business owners wish to protect themselves against the possibility that one of the other owners will transfer his or her ownership interest to an undesirable third party. If transferability of ownership is a concern, it is important to address this issue when the entity is formed.

Many partners also may wish to establish a method for handling the ownership interest of a partner who dies. It is often advisable to have the partnership buy the interest of the deceased partner and the parties may wish to agree in advance on how to value such a share, the procedure for buying the interest, and other concerns. Additionally, the partners may need to buy life insurance or make other plans to ensure that the partnership will have sufficient capital to buy the deceased partner's interest.

The partnership agreement should address these important issues:

1. restrictions on the transfer of a partnership interest;

2. a method for determining the value of a partnership interest;

3. voluntary withdrawal from the partnership by a partner;

4. the transfer of a deceased partner's interest;

5. how to handle the disability of a partner who is involved significantly in the partnership; and

6. a means of funding any required purchase of a partnership interest.

There are four basic types of business entities: the Sole Proprietorship, the Partnership, the Corporation and the Limited Liability Company (the "LLC"). See the appropriate topics below for more information about each type.

In a general partnership state laws usually provide that each member has equal rights in the management of the partnership, unless the partnership agreement provides otherwise. This one vote per person allocation of voting rights can be easily modified in a partnership agreement to provide, for example, that voting rights are based on capital contributions rather than distributed equally among all members. Additionally, a partnership agreement might require an unanimous affirmative vote before certain really important business decisions are binding. Such unusual acts that require unanimous vote often include:

1. amendment to the partnership agreement;
   
2. admission of a new partner;
   
3. consent to sell, merge or dissolve the partnership; and
   
4. sale of significant business assets.