Individuals, sole proprietors, even existing partnerships or other business entities may decide to enter into a partnership arrangement with one another. Doing so is often as easy as coming to a verbal agreement, though rarely is this approach the least costly. Choosing the right type of partnership, the total number and types of partners, and the nature of the partnership's business all play a role in the overall costs involved.
While a handshake may suffice for the simplest of business partnerships, most opt to form under more official and costly terms. This includes the legal costs of drafting partnership agreements, obtaining local and state licenses, and paying for state registration fees. Corporations that enter a partnership may have additional formation costs and considerations, such as the issuance of new stock and the expense involved with holding additional board meetings.
A general partnership is considered the simplest form of partnership, and frequently has a lower cost associated with its creation. This is, in part, because no formal or written agreement is required to create a general partnership, even if it remains advisable. However, general partnerships may expose one or more partners to legal risks and costs far in excess of any savings achieved during their formation.
Limited and Limited-Liability Partnerships
Unlike general partnerships, a limited or limited-liability partnership does require a written agreement between its partners. Legal and start-up costs are therefore more substantial, but these added expenses frequently provide partners with a reduction in legal risk that is much more in line with the protections found through incorporation or sole proprietorship. These partnership types may also reduce fiduciary-related costs, both at start-up and over time.
Unlike a corporation, partners are seen to hold equal degrees of fiduciary responsibility toward one another. This means that each partner may incur substantial costs in order to avoid a breach of fiduciary duty to other partners, which may result in additional fees paid to lawyers and accountants, both initially and on an ongoing basis.
Ultimately, partnerships are arrangements that affect each partner's tax returns. This view is certainly held by the Internal Revenue Service. Inside many partnerships, each partner receives an equal share of revenue or profit earned regardless of his contribution to the partnership as a whole. This could cost a partner significantly more in taxes compared to operating under another structure, such as a Sub-S corporation.
One approach used to avoid this dilemma is found during the drafting of partnership agreement papers, by allocating a different share of revenue or profit to partners likely to pay the least in taxes due to the partnership. Alternatively, forming a corporation and entering it into the partnership--rather than entering as an individual--may alleviate some tax issues for a partner, in exchange for greater starting costs.