Chapter 3 — Partnerships: Doing It Together

Chapter 3 — Partnerships: Doing It Together

Two cousins open a corner grocery store — one puts in $30,000, the other puts in $10,000 but works the counter six days a week.

Partnerships are the natural structure of people who start businesses together. Simple to form, flexible to run — and, precisely because they feel informal, the structure where handshake deals cause the most damage. This chapter covers the three flavors of partnership, how the taxes work, and the one document that stands between a partnership and a disaster.

The three types of partnership

General partnership. This is the default: two or more people agree to run a business together and share profits, and unless you file paperwork saying otherwise, you are a general partnership. No state filing, no fee. The catch: each partner is personally liable for the whole business — including debts and mistakes made by the other partner. If your partner signs a $40,000 supply contract without telling you, the supplier can collect from you personally.

Limited partnership (LP). General partners run the business with full personal liability; limited partners are investors — money in, profits out, no management, liability capped at what they invested. Requires a state filing ($50–$200). Common in real estate deals; rare for ordinary small businesses.

Limited liability partnership (LLP). Designed for professionals — law, accounting, medical firms. Partners are shielded from each other’s malpractice, but still liable for their own mistakes and guaranteed debts. State registration required; restricted to licensed professionals in many states.

For most small businesses started by friends, family, or spouses, the real choice is: plain general partnership (simple, fully exposed) or LLC taxed as a partnership (same tax treatment, with liability protection).

How partnerships are taxed

Partnerships are pass-through entities — the partnership itself generally pays no income tax. Profits and losses pass through to the partners, who report their share on personal returns. The partnership files an informational return, Form 1065, and each partner gets a Schedule K-1 showing their share. Example: Amine and Youssef run a food truck 50/50, netting $80,000. Each partner’s K-1 shows $40,000, taxed on his personal return plus about 15.3% self-employment tax on most of it. The partnership itself paid zero income tax.

Two honest warnings: you are taxed on your share of profits whether or not you received the cash — earn $80,000, keep $30,000 in the account for a new truck, and you still owe tax on your full $40,000. And guaranteed payments (fixed amounts paid to a partner for services) are taxed as ordinary income plus self-employment tax. Get a CPA involved before the first tax year ends.

The partnership agreement: the document that saves businesses

If you take one thing from this chapter, take this: never start a partnership without a written partnership agreement — ideally reviewed by an attorney, typically $500–$1,500, some of the best money a partnership will ever spend. The must-have clauses, in plain language:

Who puts in what, and who does what — list every contribution (cash, equipment, client lists; gifts, loans, or ownership purchases?) and every role (books, suppliers, daily operations). Unequal effort is the #1 source of partner resentment — write down expectations while everyone is still friendly.

How profits (and losses) are split, and how decisions get made — it does not have to be 50/50, and write down how losses are split too. Require unanimous consent for major moves (borrowing, selling assets, new partners); let each partner handle daily operations. Without this clause, any partner can legally bind the whole partnership to almost anything.

What happens when someone leaves, dies, or becomes disabled — a buyout formula: how the share is valued (book value? a multiple of profits? an appraisal?) and how it is paid. For death or disability, decide whether the family inherits the share or the business buys it out — most small partnerships fund the buyout with a modest life insurance policy on each partner.

How disputes get resolved — mediation before lawsuits, plus a tie-breaker for 50/50 splits. Lawsuits between partners are slow, public, and ruinous.

A cautionary story

Rachid and his childhood friend Samir open a phone-repair shop: Rachid puts in $25,000, Samir puts in $5,000 but works the counter full-time. No written agreement — “we are brothers.” Year one: $70,000 profit. Year two, Samir feels his full-time labor deserves more than the handshake 50/50; Rachid feels his $25,000 risk deserves more. Samir starts taking cash from the register “as his share.” Rachid finds out. Samir walks out and opens a competing shop across the street — taking half the regulars, whose numbers were in his phone.

With no agreement, state default rules apply — in most states that means 50/50 profit sharing regardless of who invested what, and dissolving requires going to court. The $25,000 vs $5,000? Legally irrelevant without a writing. The friendship? Over. A $1,000 attorney-drafted agreement would have answered every question in an afternoon, back when they still liked each other. Write the agreement when you are happy, so it protects you when you are not.

When partnerships work well

Partnerships are not a trap — they are often the right call, when skills genuinely complement each other (the technician and the salesperson; one has capital, the other has time), when trust is real but verified (trust gets you started; the agreement keeps you honest), when the business needs more than one person can give, and when everyone’s contribution is valued fairly in writing. For married couples, a “qualified joint venture” election can simplify taxes — but the liability picture does not change. Marriage is not a partnership agreement.

The formation is free and instant. The agreement is what makes it safe.

Key takeaways

• A general partnership is the default when two or more people run a business together — no filing needed, but each partner is personally liable for everything, including the other partner’s decisions.
• A limited partnership (LP) mixes managing general partners (fully liable) with investor limited partners (liability capped at their investment); an LLP shields professionals from each other’s malpractice but not their own.
• Partnerships are pass-through: the business files informational Form 1065, each partner gets a Schedule K-1, and each pays tax on their share — even on profits left in the business.
• Never start without a written partnership agreement covering: contributions, roles, profit/loss splits, decision-making authority, buyout terms, death/disability, and dispute resolution. Budget $500–$1,500 for attorney review.
• Without an agreement, state default rules decide everything — usually 50/50 regardless of who put in what — and breakups go to court.
• Partnerships work well when skills complement each other, contributions are fairly valued in writing, and trust is backed by a real agreement.