A partnership is a business owned by two or more people who share its profits, losses, and management without forming a corporation. The business itself pays no federal income tax; each partner reports their share of income on a personal return. That simplicity is the appeal, but partnership also carries personal liability, fiduciary duties, and tax obligations that take effect the moment two people start running a business together, whether they’ve signed anything or not.
How the Law Treats a Partnership
Under the Revised Uniform Partnership Act (RUPA), which supplies the default rules in most states, a partnership is an association of two or more persons carrying on as co-owners of a business for profit. No filing is required. No written agreement is required. If you and someone else begin splitting the revenue from a joint venture, a partnership may already exist in the eyes of the law, even if neither of you set out to create one.
When partners haven’t written their own rules, RUPA fills in the blanks. Profits and losses split equally. Every partner gets an equal vote. No one earns a salary just for participating. Those defaults apply even when capital contributions are unequal, which surprises people who assume a bigger check buys a bigger share.
Each partner also acts as an agent of the partnership. If one partner signs a contract or takes on debt in the ordinary course of business, the other partners are bound. This mutual agency is a defining feature of partnership law and the reason trust between partners matters so much. One partner’s bad deal becomes everyone’s problem.
The Four Types of Partnership
General Partnership
A general partnership is the default. All partners share management authority, and all of them carry unlimited personal liability for the business’s debts. If the partnership can’t pay a creditor, that creditor can pursue any general partner’s personal bank accounts, home, or other assets. This is the structure two people end up with when they start a business together without choosing anything more specific.
Limited Partnership
A limited partnership splits ownership into two classes. At least one general partner runs the business and accepts unlimited liability. One or more limited partners invest capital but stay out of day-to-day operations, and their losses are capped at what they put in. Limited partners trade management control for that liability protection. The structure is common in real estate and investment funds, where passive investors want exposure to profits without operational risk.
Limited Liability Partnership
A limited liability partnership shields every partner from personal responsibility for another partner’s negligence or malpractice, and all partners can actively manage the business without losing that protection. LLPs are popular with law firms, accounting practices, and other professional service groups, where one partner’s mistake shouldn’t bankrupt the others. State rules vary on how much protection an LLP provides against the partnership’s own contractual debts.
Limited Liability Limited Partnership
A limited liability limited partnership is a hybrid. It starts with the LP structure but extends liability protection to the general partner, who would otherwise have unlimited personal exposure. Not every state recognizes LLLPs, but they’re used in real estate ventures and family estate planning where the managing partner wants both control and protection.
Duties Partners Owe Each Other
Partners aren’t just business associates. The law treats them as fiduciaries. RUPA identifies two specific duties: the duty of loyalty and the duty of care.
Loyalty means you can’t secretly profit from partnership business, compete against the partnership while it’s still operating, or take an opportunity that belongs to the partnership and keep it for yourself. If you find a deal through your partnership work, you owe it to the group first. The duty of care is a lower bar. You must avoid reckless conduct, intentional wrongdoing, and knowing violations of law. Ordinary mistakes and honest business judgment don’t breach it.
Underneath both sits a general obligation of good faith and fair dealing. Partners can modify the specific contours of loyalty and care in a written agreement, but they can’t eliminate the good-faith requirement. Breach of fiduciary duty is one of the most common claims in partnership litigation, and it’s expensive to fight.
What the Partnership Agreement Should Settle
A handshake partnership works right up until it doesn’t. A written agreement replaces RUPA’s one-size-fits-all defaults with terms that actually fit your situation. At a minimum, it should address:
- Capital contributions and ownership percentages: how much each partner puts in, whether contributions can be made over time, and how ownership stakes are calculated.
- Profit and loss allocation: without an agreement, everything splits equally regardless of investment size.
- Management authority and voting: who can sign contracts, hire employees, and commit partnership funds, with dollar thresholds that require unanimous consent.
- Buy-sell provisions: what happens when a partner dies, becomes disabled, retires, divorces, or wants out, including how the departing partner’s interest is valued and who may or must buy it.
- Dispute resolution: many agreements require mediation or binding arbitration before any lawsuit can be filed.
- Dissolution terms: what triggers a wind-down and how assets are distributed when the partnership ends.
Skipping the buy-sell provision is where most partnerships set themselves up for a crisis. When a partner dies unexpectedly and no valuation method has been agreed to, the surviving partners and the deceased partner’s estate often end up in a bitter fight over what the interest was worth. Life insurance policies funded by the partnership can supply the cash to buy out a deceased partner’s share without draining operating funds.
How Partnership Income Is Taxed
Partnerships use pass-through taxation. The business itself pays no federal income tax. All income, deductions, and credits flow through to the partners, who report their shares on their personal returns. The partnership still files an informational return, Form 1065, telling the IRS how much the business earned and how it was divided.1Internal Revenue Service. 2025 Instructions for Form 1065
Each partner receives a Schedule K-1 showing their allocated share of income, losses, deductions, and credits, and those numbers go onto the partner’s Form 1040. The income is taxed at the partner’s individual rate, which can be an advantage or a disadvantage depending on the bracket.
Filing Deadline
Form 1065 is due on the 15th day of the third month after the partnership’s tax year ends. For a calendar-year partnership, that’s March 15. An automatic six-month extension is available by filing Form 7004, which moves the deadline to September 15.2Internal Revenue Service. Publication 509 (2026), Tax Calendars
Missing the deadline is costly. For returns due during 2026, the late-filing penalty is $245 per partner for each month or fraction of a month the return is late, up to 12 months. That rises to $255 per partner per month for returns due after December 31, 2026. The IRS applies this penalty even when no tax is owed, because Form 1065 is an information return and the obligation to file stands on its own.3Internal Revenue Service. Failure to File Penalty
Quarterly Estimated Payments
Because no employer is withholding taxes from partnership income, partners generally owe quarterly estimated payments. For 2026, those are due April 15, June 15, September 15, and January 15, 2027. The January payment can be skipped if you file your 2026 return and pay the full balance by February 1, 2027.4Internal Revenue Service. 2026 Form 1040-ES The safe harbor to avoid an underpayment penalty is paying at least 100% of the prior year’s tax liability (110% if adjusted gross income exceeded $150,000) or 90% of the current year’s, whichever is smaller.
Self-Employment Tax
General partners owe self-employment tax on their distributive share of partnership income. The combined rate is 15.3%, split between 12.4% for Social Security and 2.9% for Medicare, applied to 92.35% of net self-employment earnings. The Social Security portion applies only to the first $184,500 of covered earnings in 2026; the Medicare portion has no cap.5Internal Revenue Service. Topic No. 554, Self-Employment Tax6Social Security Administration. What Is the Current Maximum Amount of Taxable Earnings for Social Security
Limited partners generally don’t owe self-employment tax on their share of partnership profits. The exception is guaranteed payments for services: if a limited partner receives a fixed payment for actual work performed for the partnership, that payment is subject to self-employment tax regardless of the partner’s limited status.7Internal Revenue Service. Self-Employment Tax and Partners Guaranteed payments also count as ordinary income to the partner who receives them and are deductible by the partnership.8Office of the Law Revision Counsel. 26 U.S. Code 707 – Transactions Between Partner and Partnership
Qualified Business Income Deduction
Partners may be eligible for the Section 199A qualified business income deduction, which allows a deduction of up to 20% of qualified business income from a domestic partnership. The deduction is claimed on the partner’s individual return, not at the partnership level. Guaranteed payments and payments for services rendered in a non-partner capacity don’t count as qualified business income.9Internal Revenue Service. Qualified Business Income Deduction For specified service trades or businesses such as law, accounting, health care, and consulting, the deduction phases out at higher income levels.
Registering With the State and the IRS
A general partnership can exist without any government filing, but limited partnerships, LLPs, and LLLPs all require a certificate or registration with the state, typically through the Secretary of State’s office. Filing fees vary widely by state and entity type, from under $100 for a basic LP registration in some states to several hundred dollars in others.
After the state filing, apply for an Employer Identification Number from the IRS. This nine-digit number is the business’s tax ID and is required to open a business bank account, hire employees, and file Form 1065. The application is free, completed online, and usually produces an EIN immediately.10Internal Revenue Service. Employer Identification Number
How a Partnership Ends
Dissolution doesn’t happen overnight. It triggers a winding-up period during which the partnership finishes existing business, collects debts owed to it, and liquidates assets. No new business should be taken on during this phase.
Assets are distributed in a specific priority order. Outside creditors are paid first. Next come debts the partnership owes to individual partners, such as loans a partner made to the business, which are distinct from capital contributions. After that, partners receive their capital contributions. Anything left is divided as profits according to the partnership agreement, or equally if there is none.
The practical steps include filing a dissolution or cancellation form with the state, notifying customers and vendors, closing the partnership’s bank accounts, and canceling the EIN with the IRS. A final Form 1065 and final Schedule K-1s must be filed for the short tax year ending on the dissolution date. Partners who skip the state filing can remain on the hook for annual report fees and leave the impression that the business is still active, which creates complications years later.