Going into business with others requires planning from a legal and tax perspective. The number one most important step for a partnership, regardless of its entity type (LLC, LLP, or GP), is to create and adhere to an operating agreement.
The operating agreement will be the governing document of the partnership. There is an abundance of information available on how to properly structure operating agreements. Below is a very high-level summary of what is needed:
Name and Address
Registered Agent’s Name and Address (the registered agent is the entity responsible for the legal documents of the partnership)
Effective Date of Formation
Member-by-Member notation of liability limits (if not an LLC)
Provision for Reimbursement of Organizational/Start of Costs to Each Member
Key Management Roles and Responsibilities
Documentation of Member’s Capital Interests (This is based on the value of the contributed property. The partner’s share is determined as a percentage of the total contributed property. All partners must contribute capital, whether cash or property. The future promise of services or contribution is not allowed; there are tax consequences to that. There are options available if one partner does not have enough capital or any capital at the time of formation that would allow them to be 50/50 partners. Please contact us.)
Decision Making (Will there be a vote? Will it be written?)
Compensation (Partnerships share in final-year profit and losses. There should be no provision for a specified amount of compensation for any partner. Partners may provide services to the partnership for a fee.)
Member Meetings Frequency and Agenda
Membership Certificates (This documents the member’s name, address, percent of partnership, and transfer restrictions)
Documentation That Members Agree Not to Manage or Work for Another Entity or Its Activities
Admission of New Members (Will it be allowed or not? Majority vote or not? Required capital contribution would compete with the partnership.)
Tax and Financial Provisions:
Tax Year and Accounting Method (The most common is a tax year that ends on December 31 and a cash accounting method.)
Designation of the Tax Matters (The partner must be a member.)
Filing of Annual Income Tax Returns and Reports (Partnerships file Form 1065.)
Establishing Bank Accounts in the Name of the LLC (A checking account is mandatory.)
Title to Assets (All assets of the partnership will be in the partnership’s name.)
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Taxation of Partnership and Their Partners
A partnership is its only legal entity; however, it pays no tax. It does, however, file its own tax return (i.e., Form 1065 or the US Return of Partnership Income form). The filing deadline for partnership returns is March 15th. Form 1065 includes a profit and loss statement, balance sheet, and information on all its partners.
Each partner will be given a Schedule K-1 (i.e., Partner’s Share of Income, Deductions, Credits, etc.), which represents their share of the profit and loss from the partnership. This schedule is used by tax preparers when preparing your annual income tax return. Your share of the profit and loss will either increase or decrease your taxable income, thus the amount of tax you pay personally.
The Schedule K-1 information is a report on various forms and schedules of Form 1040. The most prevalent of these forms is Schedule E (i.e., Supplemental Income and Loss). Please contact us for assistance in filing your partnership operating agreements and/or tax returns.