The Advantages of a Partnership Agreement
There are three general forms of business entities: partnerships, corporations and sole proprietorships. Partnerships are a type of business entity with two or more people working together. During the formation of a partnership, the parties have an option to draft a partnership agreement, but it is usually not mandatory to do so.
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Ability to Contract
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One of the fundamental legal rights in the United States is the ability to contract. Generally, a person can enter a contract under any terms he desires. There are some restrictions, such as not being able to contract to commit illegal activities, as well as some protections, such as contracting with a minor. The ability to contract allows partners to agree in writing to almost anything they want. In the absence of a partnership agreement, the partnership must follow the laws of the state where the partnership is based.
Partnership Profits
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Generally, in the absence of a partnership agreement, the partners split profits based on each one's ownership percentage. For example, Partner 1 owns 40 percent of Partnership A, and the partnership's income for the year is $100,000. Partner 1 would receive $40,000. With a partnership agreement, the partners can decide how to split profits. For example, Partnership A creates a partnership agreement where Partner 1 receives 60 percent of profits while he owns 40 percent of the partnership. If Partnership A's income is $100,000, then Partner 1 receives $60,000.
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Partnership Losses
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In the absence of a partnership agreement, partnership losses are shared in the same manner as profits. However profits are split, the partnership will share the losses the same way. With a partnership agreement, the partners can share losses however they see fit. This is advantageous because partnership losses are deductible from the partners' individual tax returns.
Disagreements
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If a disagreement arises in a partnership, it may be difficult to decide how to resolve the issue. A partnership agreement allows the partners to define each party's responsibilities and identify procedures, such as arbitration, to resolve problems.
Liquidation
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State law usually determines how liquidation procedures will occur in a partnership. However, the partnership agreement can define aspects of this process, such as the order of liquidation from partners' capital accounts.
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References
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