This is part 2 of a 4 part series entitled “What Type of Business Entity Should You choose?”.
In Part 1, I discussed the various aspects of starting a business as a sole proprietorship. In this, Part 2, I will be discussing the different aspects of forming a business partnership.
One thing to keep in mind throughout this post is the difference between personal asset liability and liability for assets invested in a business partnership.
The reason people have protection under the umbrella of a business entity is in order to avoid their personal assets being exposed to liability. Personal assets are things like your house, cars, stocks, bank accounts, etc. In Texas, some, not all, of these assets are automatically exempt. This is why it is crucial to make sure your business assets and personal assets are separately protected when you form any business entity. Keep this in mind while you read, and contact us to help you walk through the process.
At Romano & Sumner, we pride ourselves on being able to thoroughly educate our clients on all of the options they have available to them. We like to make sure clients know the good, the bad, and the ugly aspects of all of their choices before moving forward. Our recommendations vary depending on each client’s circumstances. If you have further questions about making this crucial decision in starting your business, please don’t hesitate to contact us.
Let’s jump right in, shall we?
There are three kinds of partnerships to consider when forming your business entity:
A General Partnership is typically defined as being two or more people who associate in a common enterprise to make a profit. Let’s revisit our hero from the last installment of this series, Clark Kent. Clark and his friend Kenny Sumner have a great idea for a business, and they want to call it “Superheroes R Us”. Sounds like a winning title, right? After all, he is Superman…but that’s our little secret.
A General Partnership is very easy to form. You basically just have to say, “Hey, we are partners!” Under the governance of the Texas Business Organizations Code, there are no forms to file. A General Partnership should have a written business partnership agreement, but if one does not exist, then the Code has default provisions as to how it is controlled. Additionally, a business partnership can be formed even if the parties did not intend to create one.
The only caveat to all of this is if you want to operate under a business name, like “Superheroes R Us”.
In this case, Clark and Kenny would have to file an Assumed Name certificate with the county clerk in the county they intend to have a business presence, or in each county where they will regularly conduct business or render professional services. (see the Harris County Clerk’s webpage for assumed name forms and requirements)
The basic form requires:
If Clark and Kenny complete these steps, they can now provide services under the name “Superheroes R Us”.
A General Partnership sounds like a great idea, BUT consider this question…
In a General Partnership are my personal assets protected?
Each partner in a general partnership has equal rights to management of the partnership. However, each partner is also subject to “joint and several liability” for the action of the other partner.
So, what does that mean?
Imagine Clark Kent goes on assignment …as Superman… for “Superheroes R Us” and saves a bus load of school children. But, in seeing this mind-blowing feat of superhuman power, the children are all traumatized by the event, and their parents decide to sue for damages. The parents file a lawsuit against Superheroes R Us, which means Clark Kent and Kenny Sumner will both be sued.
This is troubling, given that a general partnership is so easy to form.
Remember: I don’t even have to intend to form a business partnership, to be held liable as a partner in a General Partnership.
So how do I know if I have formed a General Partnership? What should I do?
Because memories fade, it is always best to have a written business partnership agreement – in the case of me and our hero, one that includes a provision that would cover any claims filed by the school children’s parents’ claims.
In regards to taxation and reporting to the IRS – In a General Partnership, profits and losses flow to each partner, there is no double taxation.
Here’s a recap:
A Limited Partnership is typically defined as a partnership made up of one or more general partners and one or more limited partners. For example, Clark Kent wants to run “Superheroes R Us”, but needs money to purchase his storefront. Bruce Wayne has the money and he thinks Clark Kent will do a good job. However, Bruce is busy with his own career. He just wants to share in the business profits, but not have a part in running the business.
So, What do they do?
After this is filed, Clark and/or Bruce must file a report every four years listing the general partners of the Limited Partnership.
Additionally, Clark and Bruce must have an oral or written (preferred) Limited Partnership Agreement. They also need to have a registered agent for the LP. This is a person who receives notices on behalf of the business partnership, most likely Clark. The individual or company must be a resident of Texas and they must have consented to be the registered agent.
Given that this is a more expensive and involved option, why would I want to do it?
First, it is attractive to investors. Bruce Wayne has the money that Clark Kent needs, yet he does not want to run the business. He is willing to limit his liability to the amount of money he puts into the business partnership in exchange for his profit percentage. If Clark traumatizes a busload of children, Bruce’s only liability exposure is the amount he invested in the Limited Partnership.
Second, while Bruce is partners with Clark, he cannot exert control over the business partnership. By definition he is a limited partner. If he starts meddling in the day-to-day operation of “Superheroes R Us”, then he risks losing his limited liability
Are my personal assets protected in a Limited Partnership?
It depends on whether you are the general partner or the limited partner.
As general partner, Clark still has full liability for his personal assets. HOWEVER, Bruce’s personal assets are protected so long as he remains a passive partner.
In regards to taxation and reporting to the IRS – in a limited partnership, there is still no double taxation. An EIN must be obtained through the IRS for the business. Additionally, limited partnerships in Texas that have an income above $1.5 million are now subject to franchise (margin) tax for active income. (this is the current amount as of October 2015)
In our General Partnership scenario earlier in this post, Clark traumatized a busload of school children. The parents decided to file a lawsuit. Because of their business entity both Clark Kent and Kenny Sumner were held responsible and liable for the damages.
In our Limited Partnership scenario, if Clark traumatizes a busload of children, Bruce’s only exposure to liability was the amount he invested in the Partnership.
Wouldn’t it be great if there were a way to protect the other partners from liability in either one of these business partnerships?
This is where the Limited Liability Partnership comes in.
A Limited Liability Partnership, or LLP, can be either a General Partnership or a Limited Partnership that wants some protection for its General Partner from acts of other partners. By filing an application with the Texas Secretary of State, the General Partner is granted some personal protection from liability.
What do I need to know about filing an application for a Limited Liability Partnership?
Limited Liability Partnership Pros and Cons
In regards to taxation and reporting to the IRS – in a Limited Liability Partnership, there is no double taxation. An EIN must be obtained through the IRS for the business. Additionally, LLP’s in Texas are now subject to franchise (margin) tax for active income just like Limited Partnerships.
Weighing the advantages of a partnership against the disadvantages is a tough task. Taking the first steps to decide how you will conduct your business can be the most crucial time in forming a business entity. If all of this seems like too much to consider or sift through on your own, we are happy to help. We take great pride and pleasure in helping our clients navigate through the legal aspects of forming and building a business. Contact us today and let us know how we can help you.
Business Meeting by thetaxhaven
school buses by Dean Hochman
Batman vs. Superman by JD Hancock
Romano & Sumner, PLLC