General vs. Limited Partnerships: Choosing the Right Structure

Partnerships: The Basics

A partnership is a business owned by two or more people. Unlike an LLC or corporation, a general partnership can form without any formal filing — two people start doing business together, and a partnership exists. That simplicity is both its appeal and its danger.

There are three main types of partnerships, each with different liability structures and levels of formality.

General Partnership (GP)

A general partnership is the simplest multi-owner business structure. All partners share in the management, profits, and — critically — the liabilities of the business.

Key characteristics:

• No formation filing required — exists automatically when two or more people do business together
• All partners have unlimited personal liability — each partner is responsible for the full debts and obligations of the business, including those caused by other partners
• Joint and several liability — a creditor can go after any one partner for the full amount owed, not just that partner's share
• Each partner can bind the business — any partner can enter contracts, take on debt, and create obligations that all partners are liable for
• Pass-through taxation — partnership income flows to partners' personal returns via Schedule K-1

The unlimited liability and mutual agency make general partnerships risky. If your partner signs a bad contract or causes a lawsuit, your personal assets are on the line. For this reason, general partnerships are rarely recommended for anything beyond very small, informal ventures.

Limited Partnership (LP)

A limited partnership has two classes of partners:

• General partners manage the business and have unlimited personal liability (same as in a GP)
• Limited partners invest capital but do not participate in management, and their liability is limited to their investment

LPs are commonly used in real estate investing, film production, and certain professional services where some partners are passive investors.

Key characteristics:

• Must file a Certificate of Limited Partnership with the state
• At least one general partner required — this person has full management authority and unlimited liability
• Limited partners risk only their investment — they cannot participate in management or they may lose their limited liability status
• Pass-through taxation — same as a general partnership
• More complex to set up than a GP, but still simpler than a corporation

The catch with limited partnerships: if a limited partner starts participating in day-to-day management, courts can treat them as a general partner — stripping away their liability protection.

Limited Liability Partnership (LLP)

An LLP provides liability protection to all partners, not just limited partners. In an LLP, no partner is personally liable for the negligence or malpractice of another partner.

LLPs are most commonly used by professional service firms — law firms, accounting firms, and medical practices — where malpractice risk is a major concern.

Key characteristics:

• Must register with the state — filing requirements vary
• All partners have limited liability for the acts of other partners
• Partners are still liable for their own negligence and for contractual obligations they personally guarantee
• Not available in all states for all professions — some states restrict LLPs to licensed professionals
• Pass-through taxation

How Partnership Taxation Works

All partnership types are pass-through entities. The partnership itself does not pay income tax. Instead:

1. The partnership files an informational return (Form 1065) with the IRS.
2. Each partner receives a Schedule K-1 showing their share of income, deductions, and credits.
3. Partners report this on their personal tax returns and pay tax at their individual rates.
4. Partners pay self-employment tax on their share of partnership income (with some exceptions for limited partners).

Partners typically need to make quarterly estimated tax payments since there is no employer withholding.

The Partnership Agreement: Do Not Skip This

Every partnership needs a written partnership agreement. Without one, your state's default partnership law applies — and those defaults rarely match what the partners actually want.

Your partnership agreement should address:

• Capital contributions — how much each partner invests
• Profit and loss allocation — it does not have to match ownership percentages
• Management authority — who makes what decisions, and what requires unanimous consent
• Draws and distributions — when and how partners take money out
• Adding new partners — approval process and terms
• Partner departure — voluntary withdrawal, retirement, death, disability
• Buyout provisions — valuation method, payment terms
• Dispute resolution — mediation, arbitration, or litigation
• Dissolution — under what circumstances and how assets get divided

The number one cause of partnership disputes is unwritten assumptions. Put everything in writing before you need it.

Why Most Small Businesses Should Choose an LLC Instead

If you are starting a business with one or more partners, an LLC is almost always a better choice than a partnership. Here is why:

• All members get liability protection — no one has unlimited personal liability
• Flexible management structure — members can participate in management without losing liability protection
• Same pass-through taxation — LLCs taxed as partnerships get the same tax treatment
• Can elect S-Corp taxation — for additional tax savings at higher income levels
• Clearer legal framework — the operating agreement serves the same purpose as a partnership agreement but within a more protective structure

The main scenario where a partnership structure still makes sense is when a specific industry or regulatory requirement demands it (certain professional services), or when the LP structure is needed for passive investor relationships.

Common Partnership Pitfalls

• No written agreement. Verbal partnerships are legal but disastrous when disputes arise.
• Equal splits without equal work. A 50/50 split sounds fair until one partner works 60 hours a week and the other works 20.
• No exit strategy. How does a partner leave? Without a buyout provision, you are stuck.
• Mixing friendship and business. Going into business with a friend without clear business terms is a proven way to lose both the business and the friend.
• Ignoring liability exposure. In a general partnership, you are personally on the hook for everything your partner does in the name of the business.

Bottom Line

Partnerships are simple to start but dangerous if not properly structured. General partnerships expose all partners to unlimited liability. Limited partnerships protect passive investors but require at least one general partner to bear full risk. For most small business owners forming a business with partners, an LLC provides the same tax benefits with far better liability protection. Whatever structure you choose, get a written agreement in place from day one.