A business partnership is a for-profit enterprise owned by two or more people who agree to share its profits and losses. The partnership itself does not pay federal income tax; income flows through to the partners, who report it on their own returns.1Office of the Law Revision Counsel. 26 USC 701 – Partners, Not Partnership, Subject to Tax The trade-off for that simplicity is exposure: in the most common form, each partner’s personal assets are on the line for the business’s debts.
A partnership can exist without any paperwork at all. When two or more people start doing business together and splitting profits, the law treats them as partners even if nothing was signed.2Legal Information Institute. Partnership Each partner acts as an agent for the others, which means a deal one partner makes in the ordinary course of business binds everyone. That is why the choice of partners matters as much as the choice of business.
The Four Types of Partnerships
General Partnership
A general partnership is the default form. All partners manage the business and share unlimited personal liability for its debts. If the partnership can’t pay a creditor, that creditor can pursue any individual partner’s personal accounts, real estate, and other assets for the full amount owed. Joint and several liability means a single partner can end up responsible for obligations another partner created. In most states, no filing is required — the partnership exists the moment the partners start doing business.
Limited Partnership (LP)
A limited partnership has at least one general partner who runs the business and carries unlimited liability, plus one or more limited partners who function as investors. Limited partners contribute capital and share in profits, and their potential losses are capped at what they put in. Under the 2001 Revised Uniform Limited Partnership Act, now adopted in a majority of states, limited partners keep that protection even if they participate in management. Some states still follow older versions that can strip protection from limited partners who get too involved in daily operations, so this is worth confirming in your state. An LP must file a certificate with the state to exist.
Limited Liability Partnership (LLP)
An LLP shields each partner from personal liability for the negligence or malpractice of the other partners. You remain responsible for your own errors and for the general debts of the business, but if a partner mishandles a client matter, that lawsuit cannot reach your personal assets. This structure is common at law firms, accounting practices, and architecture firms. LLPs require a state filing, and some states restrict the form to licensed professionals.
Limited Liability Limited Partnership (LLLP)
An LLLP combines the LP structure with LLP-style protection. The key difference from a standard LP is that the general partner also gets a liability shield. This appeals to real estate ventures and family investment vehicles where the managing partner wants active control without unlimited personal exposure. Not every state recognizes LLLPs, and even where they do, contractual obligations like personal guarantees on loans can override the protection.
What Partners Owe Each Other
Partners owe two fiduciary duties: loyalty and care. The duty of loyalty means you cannot compete with the partnership, take business opportunities for yourself, or deal with the partnership when you have a conflicting interest. The duty of care means you must avoid grossly negligent or reckless decisions, though honest mistakes made in good faith do not create liability. A partnership agreement can adjust these duties somewhat, but it cannot eliminate them.
By default, every partner has an equal right to manage the business. Ordinary business matters are decided by majority vote, and actions outside the normal scope of the business generally require unanimity. Partnerships that fail often do so because the partners assumed informal understandings would hold up. They rarely do.
What the Default Rules Give You Without an Agreement
State default rules fill any gaps in a partnership arrangement, and those defaults are often not what partners expect. Under the framework most states use, profits and losses are split equally regardless of who contributed more capital or does more work. Every partner gets an equal say in management. No partner draws a salary unless the others agree. And if any partner decides to leave, the default remedy in many states is dissolution of the entire partnership.
This is where partnerships come apart. Two partners who each put in $50,000 might feel fine splitting profits 50/50. Change that to one partner contributing $200,000 and another contributing $20,000 plus a skill set, and an equal split feels very different. Without a written agreement, an equal split is what the law gives you. A partnership agreement covering capital contributions, profit allocation, management authority, decision-making procedures, and exit terms costs far less than the dispute it prevents.
How to Form a Partnership
The formation process depends on which type of partnership you are creating. A general partnership technically exists the moment you start doing business together, but taking formal steps still makes sense.
- Choose a business name that complies with your state’s naming rules and does not infringe an existing trademark. If the name differs from the partners’ legal names, you may need a “doing business as” registration.
- File formation documents with the state if you are forming an LP, LLP, or LLLP. This typically means a certificate of limited partnership or a registration statement filed with the secretary of state. Filing fees vary by state and entity type.
- Designate a registered agent if you file with the state. That is a person or company authorized to accept legal documents on the business’s behalf.
- Get an Employer Identification Number from the IRS. Every partnership needs one. You can apply online at irs.gov for free and receive the number immediately. Register the entity with the state first, since applying for an EIN before the state filing can cause delays.3Internal Revenue Service. Employer Identification Number4Internal Revenue Service. Get an Employer Identification Number
- Draft a partnership agreement. It is not legally required for a general partnership, but it defines how the business actually runs: capital contributions, profit splits, voting rights, exit terms, and dispute resolution.
How Partnership Income Is Taxed
A partnership does not pay federal income tax. All income and losses pass through to the individual partners, who report them on their personal returns.1Office of the Law Revision Counsel. 26 USC 701 – Partners, Not Partnership, Subject to Tax The partnership itself files Form 1065, an informational return reporting total income, deductions, and credits.5Internal Revenue Service. About Form 1065, U.S. Return of Partnership Income For calendar-year partnerships, Form 1065 is due March 15.6Internal Revenue Service. Publication 509 – Tax Calendars
Each partner receives a Schedule K-1, which breaks out that partner’s share of income, deductions, and credits based on the allocation percentages in the partnership agreement.5Internal Revenue Service. About Form 1065, U.S. Return of Partnership Income Those figures transfer to your personal Form 1040 and are taxed at your individual rate. Your share is taxable whether the partnership distributes cash to you or not.
Late filing carries a real penalty. If the partnership misses the Form 1065 deadline without an extension, the IRS charges $255 per partner for each month or partial month the return is late, up to 12 months.7Internal Revenue Service. Instructions for Form 1065 (2025) For a five-partner firm, that is $1,275 per month and a maximum of $15,300. The penalty applies unless the partnership shows reasonable cause.8Office of the Law Revision Counsel. 26 USC 6698 – Failure to File Partnership Return
Self-Employment Tax
Partnership income also triggers self-employment tax for most partners, which funds Social Security and Medicare. The combined rate is 15.3 percent: 12.4 percent for Social Security on earnings up to $184,500 in 2026, plus 2.9 percent for Medicare on all earnings.9Social Security Administration. Contribution and Benefit Base An additional 0.9 percent Medicare surtax applies to self-employment income above $200,000 for single filers or $250,000 for married couples filing jointly.
Rules differ by role. General partners owe self-employment tax on their entire distributive share of partnership income plus any guaranteed payments.10Internal Revenue Service. Entities 1 Limited partners pay self-employment tax only on guaranteed payments for services; their distributive share of ordinary income is excluded.11Office of the Law Revision Counsel. 26 USC 1402 – Definitions That makes limited partnership structures tax-efficient for partners who put up capital but do not perform significant services.
Guaranteed Payments
Partners do not receive salaries in the traditional sense. Partnerships instead use guaranteed payments, which are fixed amounts paid to a partner regardless of whether the business turns a profit. They compensate a partner for services or for the use of capital.12Internal Revenue Service. Publication 541 (12/2025), Partnerships
The partnership deducts guaranteed payments as a business expense on Form 1065, which reduces the remaining income allocated to all partners. The receiving partner reports the payment as ordinary income on Schedule E of their personal return, alongside their distributive share of remaining partnership income.12Internal Revenue Service. Publication 541 (12/2025), Partnerships Guaranteed payments are subject to self-employment tax for every partner who receives them, including limited partners who are otherwise exempt on their share of ordinary income.11Office of the Law Revision Counsel. 26 USC 1402 – Definitions
Estimated Payments and the QBI Deduction
Partnership income is not subject to withholding the way a paycheck is, so partners generally need to make quarterly estimated tax payments. You are required to pay estimated taxes if you expect to owe at least $1,000 when you file.13Internal Revenue Service. Estimated Taxes The four due dates are April 15, June 15, September 15, and January 15 of the following year.14Internal Revenue Service. Estimated Tax Missing these payments triggers an underpayment penalty even if you are ultimately owed a refund.
Eligible partners can also claim the Qualified Business Income (QBI) deduction under Section 199A, which was made permanent by the One Big Beautiful Bill Act in 2025. Qualifying partners can deduct up to 20 percent of their share of partnership income. For 2026, the deduction begins phasing out at $201,750 of taxable income for single filers and $403,500 for married couples filing jointly. Partners in specified service businesses like law, medicine, and consulting face additional restrictions as income rises.
Selling or Transferring a Partnership Interest
You cannot simply sell your partnership interest to a stranger the way you would sell publicly traded stock. Partnerships rest on personal relationships, and the law reflects that. Under default rules, a partner can transfer the economic rights to their share of profits but cannot transfer management rights or make the buyer a full partner without the consent of all other partners.
Most well-drafted partnership agreements go further. A right of first refusal is common: before you can sell to an outsider, existing partners get the chance to buy at the same price. Some agreements require unanimous or majority consent for any transfer, and many limit transfers to family members, affiliates, or existing partners. Buy-sell provisions establish a process for transfers triggered by a partner’s death, retirement, or disability, often with a predetermined valuation formula so nobody negotiates price under pressure.
If an agreement is silent, the default rules create an awkward result: a buyer with the right to receive distributions but no vote, no access to books, and no management authority. That is a bad deal for the buyer and an uncomfortable arrangement for the remaining partners.
When a Partnership Ends
A partnership can dissolve for several reasons. The most straightforward is that the partners decide they are done. In an at-will partnership with no fixed term, any partner can trigger dissolution by saying they want out. In a partnership with a defined term, dissolution typically happens when the term expires, though it can also be triggered early if a partner dies, declares bankruptcy, or is expelled, and at least half the remaining partners vote to wind up the business within 90 days. A court can also order dissolution when continuing the business has become impractical because of deadlock, persistent misconduct, or economic futility.
Dissolution does not mean the business vanishes overnight. It starts a winding-up period during which the partnership finishes existing business, collects debts owed to it, and converts assets to cash. Outside creditors are paid first, then any debts the partnership owes to partners (like a loan a partner made to the business), and whatever remains goes to the partners based on their capital account balances and profit-sharing percentages. If liabilities exceed assets, general partners are personally responsible for the shortfall.
Beneficial Ownership Reporting
The Corporate Transparency Act originally required most domestic entities, including partnerships, to file beneficial ownership reports with FinCEN. That requirement was significantly narrowed in 2025: FinCEN issued an interim final rule exempting all domestic entities from beneficial ownership reporting.15FinCEN.gov. FinCEN Removes Beneficial Ownership Reporting Requirements for U.S. Companies and U.S. Persons Under the current rule, only entities formed under the law of a foreign country and registered to do business in the United States must report.16FinCEN.gov. Frequently Asked Questions If your partnership was formed in a U.S. state, you have no FinCEN filing obligation as of 2026.