Partnerships: General, Limited, and LLP Explained

If you and someone else start working together toward a profit - splitting revenue, sharing decisions, running a joint operation - you are very likely already a general partnership, whether or not you ever meant to form one and whether or not you ever signed anything. That default status carries a serious cost: each general partner is personally on the hook for the whole partnership's debts, and for what the other partners do in the course of the business. Two other structures - the limited partnership (LP) and the limited liability partnership (LLP) - exist specifically to change that liability picture. This guide walks through how each works, why a written partnership agreement matters more than almost any other document you'll sign, and how partnership taxation actually works.

The default: general partnerships happen automatically

Under state partnership law, a general partnership is typically defined as an association of two or more people who carry on a business for profit as co-owners. Most states have adopted some version of the Uniform Partnership Act, but the exact text and rules vary by state - so the specifics below are the general shape, not your state's precise statute. You do not have to file anything, sign anything, or even intend to form a partnership. If you and a friend start selling something together and splitting the money, you can be a general partnership in the eyes of the law even if you never used that word.

That default status has two liability consequences that surprise a lot of people:

• Unlimited personal liability for partnership debts. If the partnership can't pay a supplier, a landlord, or a lender, creditors can generally come after each partner's personal assets - not just what's left in the business - to satisfy the whole debt, not just that partner's "share."
• Liability for your partners' acts. Each general partner can typically bind the partnership to contracts and obligations, and each partner can be held personally responsible for another partner's actions taken in the ordinary course of the business - including that partner's negligence or bad judgment. You can end up owing money because of a decision you never made and may not have known about.

This is the same unlimited exposure a sole proprietor has, except now it's multiplied by however many partners you have, and each of you is exposed to the others' conduct too. If you take nothing else from this article: going into business with someone as a general partnership, with no other structure and no written agreement, is one of the highest-liability arrangements in American small business law.

Limited partnerships (LPs): splitting the roles

A limited partnership has at least one general partner, who runs the business and keeps the same unlimited personal liability described above, and at least one limited partner, whose personal liability is generally capped at what they put into (or agreed to put into) the business. In exchange for that liability shield, a limited partner traditionally has to stay out of day-to-day management - historically, a limited partner who takes an active management role could risk being treated like a general partner for liability purposes, though the details of how "control" is defined vary by state law.

LPs are common where one person or group is contributing money and wants liability protection while someone else runs the operation - real estate deals and investment funds are classic examples. LPs must generally be formed by filing with the state (unlike a general partnership, which forms automatically), and filing requirements, fees, and paperwork vary by state - check your state's Secretary of State office for what's required.

Limited liability partnerships (LLPs): shielding all the partners

An LLP is built to solve the problem an LP doesn't: what if every partner wants to be actively involved and get liability protection? In an LLP, all the partners can participate in running the business, and - unlike a general partnership - partners are generally shielded from personal liability for the partnership's debts and, importantly, from vicarious liability for the malpractice, negligence, or misconduct of the other partners.

A few things to know before you assume an LLP solves everything:

• The scope of the shield varies by state. Some states give LLP partners a "full shield" against essentially all partnership liabilities; others give a narrower "partial shield" that protects you from your partners' malpractice and misconduct but leaves you exposed to certain other partnership debts. You need to check your specific state's LLP statute, not assume the broadest version applies.
• Many states restrict LLPs to licensed professionals. Historically the LLP form grew out of law and accounting firms wanting protection from a partner's malpractice liability, and a number of states still limit LLP status to licensed professions (law, accounting, medicine, architecture, and similar fields) rather than opening it to any business. Whether your business qualifies is a state-law question.
• You still don't escape your own conduct. No partnership form - LP, LLP, or otherwise - shields a partner from liability for their own negligence, fraud, or wrongdoing, or from a personal guarantee they signed.

Because both LP and LLP status generally require a state filing and ongoing state compliance (and many states also require annual reports or renewal filings to keep the status active), confirm the current formation steps, filing fees, and any ongoing filing deadlines with your state's Secretary of State or equivalent business-filing agency. Missing a required renewal can sometimes lapse the liability protection you filed for in the first place - the exact consequences vary by state, so don't guess.

Why a written partnership agreement is not optional

If you form a partnership - of any type - without a written agreement, state default rules fill in the gaps, and those defaults are often not what any of the partners would have chosen. A common default, for example, treats partners as sharing profits and losses equally regardless of how much money, time, or work each one actually put in. That may be fine for you. It may also be a serious mismatch with what you and your partner(s) actually agreed to informally.

A solid partnership agreement is the single highest-leverage document you can create before you start operating together. At minimum, it should address:

• Ownership splits and capital contributions. Who put in what - cash, property, labor, existing assets - and what percentage of profits, losses, and ownership each partner has as a result.
• Decision-making authority. What requires unanimous consent, what a majority can decide, and what any one partner can do alone. Without this, a single general partner can potentially bind the whole partnership to a deal the others never agreed to.
• How profits and draws are handled. When and how partners get paid, and how that differs from their share of taxable income (see the tax section below - these are not the same thing).
• What happens if a partner wants out. Buyout terms, valuation method, notice period, and whether remaining partners have a right of first refusal.
• What happens if a partner dies, becomes disabled, or wants to sell to an outsider. Without a plan, a deceased partner's ownership interest can pass to their heirs - who may have no interest in or ability to run the business alongside you.
• Dispute resolution. How disagreements between partners get resolved before they become litigation.
• Dissolution. What triggers winding down the partnership and how remaining assets and liabilities get divided.

State default partnership law was not written with your specific business and your specific relationship in mind - it's a generic backstop. A written agreement, drafted or at least reviewed by a business attorney licensed in your state, replaces those generic defaults with terms you actually chose. This is true even for partnerships between close friends or family members - especially between close friends or family members, since informal understandings are exactly what tend to fall apart under financial stress.

How partnerships are taxed: pass-through, not double

A partnership - general, limited, or LLP - is generally a pass-through entity for federal income tax purposes. The partnership itself typically doesn't pay federal income tax on its profits. Instead:

• The partnership files an informational return, Form 1065, with the IRS, reporting the partnership's total income, deductions, gains, and losses.
• The partnership issues each partner a Schedule K-1, which reports that partner's share of the partnership's income, deductions, and credits for the year.
• Each partner reports their K-1 amounts on their own personal federal income tax return and pays tax on their share - even if the partnership didn't actually distribute cash to them that year. Being allocated income on paper and receiving a cash distribution are two different things, and a lot of new partners are caught off guard by owing tax on profits they never saw in their bank account.

General partners who are actively working in the business typically owe self-employment tax on their share of partnership earnings from that work, in addition to regular income tax. The self-employment tax rate is 15.3% - 12.4% for Social Security (up to an annually-adjusting wage base) and 2.9% for Medicare. Because no employer is withholding taxes on a partner's behalf, partners generally need to make quarterly estimated tax payments throughout the year; exact due dates and any state-level estimated tax rules vary, so confirm the current schedule on irs.gov and with your state tax agency.

Many partners are also eligible for the Qualified Business Income (QBI) deduction under Internal Revenue Code Section 199A, which allows eligible owners of pass-through businesses to deduct up to 20% of their qualified business income, subject to income-based limits and other rules. Whether you qualify and how much you can deduct depends on your income, the type of business, and other factors that are genuinely worth discussing with a CPA rather than guessing at.

None of the annually-adjusted numbers behind these rules - the Social Security wage base, current tax brackets, or similar indexed figures - are stable from year to year, so this article intentionally doesn't state them. Confirm the current-year figures directly at irs.gov before you rely on them.

What to do if you're starting - or already running - a partnership

1. Figure out which structure you actually have (or want). If you and someone else are already operating together with no filing on record, you are very likely a general partnership by default right now. Decide whether that unlimited, shared liability is acceptable or whether an LP, LLP, or a different entity altogether (like an LLC, which is a separate structure not covered here) fits better.
2. Check your state's requirements. LP and LLP status generally require a state filing, and many states require ongoing annual reports or renewals to keep that status active. Fees, forms, and deadlines vary by state - your state's Secretary of State (or equivalent business-filing office) is the place to confirm current requirements.
3. Get a written partnership agreement in place - before problems start, not after. A business attorney licensed in your state can draft or review one so it reflects your actual deal and fills gaps that state default law would otherwise fill for you.
4. Talk to a CPA about your tax situation. How income will be allocated, what your estimated tax obligations will look like, and whether a tax election (like electing corporate tax treatment for an LLC, if that's your structure) makes sense are all worth a real conversation with a tax professional, not a guess.
5. Get an EIN for the partnership and keep partnership finances in a separate bank account from personal funds - commingling funds can undermine liability protections and makes bookkeeping and tax filing much harder.
6. If you're bringing on employees, your obligations as an employer - wages, workplace safety, anti-discrimination rules that phase in at certain employee counts - are a separate topic; see observed.org's employment coverage for the employer's side of that.

Free help is available if hiring a lawyer or accountant up front isn't realistic yet: the U.S. Small Business Administration (sba.gov) and your local Small Business Development Center or SCORE chapter offer free or low-cost guidance on entity choice and getting started. If your partnership is facing business debt it can't pay, that's a bigger topic than this article covers - see observed.org's bankruptcy coverage for how business debt and personal guarantees are handled there.

Frequently asked questions

Do I need to file anything to form a general partnership?

Generally no - a general partnership typically forms automatically under state law the moment two or more people start co-owning and operating a business for profit, with no filing required. That's exactly what makes it risky: people end up in a general partnership, with full personal liability, without ever deciding to. Some states or localities may still require a "doing business as" (DBA) or trade-name registration, and that requirement varies - check with your state or county.

If I'm a limited partner, am I ever personally liable?

Generally your liability is capped at what you contributed or agreed to contribute, as long as you stay within the limited partner role. But you can lose that protection if you take on an active management role that crosses into what your state treats as "control," and you remain liable for your own wrongdoing (like fraud) and for any personal guarantee you sign. The line for what counts as too much control varies by state - if you're a limited partner who also wants to be involved in operations, get state-specific advice before assuming you're protected.

Can an LLP be formed for any kind of business, or just certain professions?

It depends on your state. LLPs originated as a structure for licensed-professional firms (law, accounting, and similar fields), and a number of states still restrict LLP status to licensed professions rather than allowing any business to form one. Other states allow LLPs more broadly. Check your state's Secretary of State for what your state allows.

Does an LLP protect me from a partner's mistakes?

Generally, yes - that's the core purpose of the LLP form: shielding each partner from personal liability for another partner's malpractice, negligence, or misconduct. But the scope of that shield varies by state (some are "full shield," some "partial shield"), and it never protects you from liability for your own conduct or from a debt you personally guaranteed.

Do I pay tax on partnership profits I don't actually receive as cash?

Yes, generally. A partnership's income "passes through" and is taxed to the partners based on their allocated share as reported on Schedule K-1, whether or not the partnership actually distributes cash to match that allocation. This is a frequent surprise for new partners and is one of many reasons a partnership agreement should spell out when and how distributions are made.

This article provides general business and tax information, not legal, tax, or financial advice, and does not create an attorney-client or accountant-client relationship. For decisions about your specific partnership, consult a business attorney and a CPA licensed in your state.