California Corporations Code 16202(a) defines a partnership as "an association of two or more parties to carry on as co-owners a business for a profit, regardless of whether the persons intend to form a partnership."

This is an important definition, because two or more people may work together yet not consider or intend for themselves to be in a legal partnership.

However, California law causes any business that meets the above definition as a partnership, regardless of the state of mind of the partners.

Partnerships are governed by California's Uniform Partnership Act of 1994 (RUPA), which sets the default regulations that apply in the absence of a written partnership agreement. Most of the regulations in RUPA can be overridden by having a written partnership agreement among the partners. Where the partnership agreement is silent, the provisions of RUPA are used to settle any controversies.

Features of Partnerships

The two chief features of a partnership are:

(1) Pass-through taxation, and

(2) Unlimited liability for general partners.

Partnership Taxation

The income of partnerships will "pass through" to the individual partners, who report their income on Schedule K of the IRS Form 1040. There is no "entity level" taxation, as exists for C Corporations. The individuals are taxed on partnership income at their ordinary individual tax rate. In this regard, partnership taxation is similar to that of a sole proprietorship.

In reality, however, partnership taxation is one of the most complex and convoluted areas of tax law. It takes into account a much wider variety of tax issues than would a sole proprietorship. For this reason, a business that is considering operating as a partnership should seek the tax advice of an attorney or CPA who specializes in partnership taxation.

Unlimited Liability for General Partners

In a partnership, as in a sole proprietorship, each general partner is personally liable for all of the debts and obligations of the partnership. If the partnership is sued, and is obligated to pay a judgment, all members of the partnership will be held liable, regardless of their involvement in the act which caused the injury.

No protection is offered by the partnership form. The only way to avoid personal liability is to consider using a Limited Partnership, or other entities such as a Limited Liability Company (LLC), or a Professional Corporation.

Limited Partnerships

There are two classes of partners in a Limited Partnership:

    (1) General Partners and

    (2) Limited Partners.

General Partners are those partners who have control over and manage the partnership's activities.

Limited Partners - often referred to as "Silent Partners" - are those partners who merely contribute capital to the partnership, but have no say in the ongoing, day-to-day operation of the partnership. They are passive investors who possess neither the right to participate in the management of the limited partnership's business nor the power to bind the limited partnership under any agreement or undertaking.

Unlike General Partners, Limited Partners are not personally liable for the debts and obligations of the partnership. They may, however, be liable up to the amount of their capital contribution - that is, they may lose their investment in the partnership, but creditors generally may not attach the assets of a Limited Partner, except in unusual circumstances.

Loss of Limited Partner Status

Limited Partners who exercise control over the partnership, or participate in the management of the partnership, may be held to be General Partners, and thereby lose their liability protection.

California Corporations Code 15632(b) sets forth activities in which a limited partner may engage that will not undermine his or her limited liability status. The activities include:

(1) Being an employee, agent, or independent contractor for the partnership or the general partner of the partnership;

(2) Being an officer, director, or shareholder of a corporate general partner of the partnership or a member, manager, or officer of a limited liability company that is a general partner of the partnership;

(3) Consulting with or advising the general partner with respect to the business of the limited partnership; and

(4) Exercising any right or power permitted to limited partners.

Conclusion

For a variety of reasons, the partnership entity may not be the ideal business entity for you. If your desire is to participate in the management of your company, yet do not wish to be held personally liable for its debts and obligations, you may need to consider choosing a different entity.

A qualified attorney can assist you in choosing an entity that is appropriate for your needs.

We welcome the opportunity to discuss your business and legal needs in greater detail.