As a new business owner, one of your most important decisions is determining what form of ownership will best meet your business needs. Selecting the best structure for your business should be a carefully planned process that is discussed with a qualified professional such as an enrolled agent, certified public accountant, or attorney who specializes in this area. In addition, as your business grows over time, you may want to evaluate if a new form of ownership should be used to achieve better results.
General partnerships must have two or more persons engaged in a business for profit. The general partnership is not a separately taxed entity. It is considered a conduit where the profit or loss of the business flows through to the partners. Partnership income is taxed as income to the partners. Losses may be subject to limitations. The partners report their share of the partnership profit or loss on their individual income tax returns even if their share of those profits is not actually distributed to them.
The partners decide the entity’s structure, allocation of profits and losses, and the timing and amount of distributions. A formal written partnership agreement is advisable. Partnerships are very flexible and offer a variety of possible ownership and management structures.
General partners are jointly and severally liable for all legal and financial obligations of the partnership and for all wrongful acts of any partner acting in the ordinary course of the partnership’s business.
Key Features of General Partnerships
- It is a flexible form of business and relatively easy to set up.
- A general partnership must have more than one owner, unlike a sole proprietorship.
- The cost to form one is normally less expensive than forming a corporation.
- The general partnership does not pay income tax. A partnership is considered a pass-through entity, meaning that each partner’s share of the partnership’s profits, losses, deductions, credits, etc., will pass-through to each individual partner and those items will be reported on each partner’s tax return in accordance with their written agreement. Losses may offset income, but may be subject to limitations.
- It exists as long as the partners agree it will and as long as there are at least two partners. This is subject to limitations imposed by California law.
How to Form General Partnerships
- A partnership is formed when two or more persons agree to carry on a business and/or other endeavor for profit.
- A formal written partnership agreement is advisable.
- A Statement of Partnership Authority (Form GP-1) may be filed with the Secretary of State at the option of the partners. This document specifies the authority, or limitations on the authority, of some or all of the partners to enter into transactions on behalf of the partnership and any other matter. The Secretary of State will assign a 12-digit filing number. Keep this filing number for your tax records. Contact the California Secretary of State at 916.657.5448 or go to sos.ca.gov for more information.
- The partners should establish a separate bank account in the name of the partnership for its financial operations.
- Partners should consider an evaluation of the types of risks the partnership might encounter in connection with its operations. Consultation with attorneys and insurance brokers in this area is advisable.
- Most cities and counties require a business license, various permits, and/or registration to do business within their city or county limits. If you are doing business in multiple cities or counties, you may be required to have multiple licenses. Contact the business licensing department of the city and/or county directly where your business will primarily be located for specific rules and regulations. The Governor’s CalGold online database at calgold.ca.gov, the Governor’s Office of Business and Economic Development (GO-Biz) at business.ca.gov, and the California Business Portal at businessportal.ca.gov all provide links and contact information to agencies that administer and issue business licenses, permits, and registration requirements from all levels of government.
- Contact your local Chamber of Commerce or call the statewide Chamber of Commerce at 800.331.8877 for information for your area and referrals to other agencies.
- If required, register a fictitious name, also referred to as “Doing Business As” or DBA, refer to Appendix 1 in this booklet for more information.
Tax Return Filing Guidelines for General Partnerships
- Every general partnership that engages in a trade or business in California or earns income from California sources must file an informational return, California Form 565, Partnership Return of Income.
- Generally, the due date of the Form 565 is the 15th day of the 3rd month after the close of the general partnership’s taxable year.
- The general partnership’s items of income, deductions, and credits flow through the partnership to its partners and are reported on the California Schedule K-1 (565), Partner’s Share of Income, Deductions, Credits, etc.
- The general partnership provides each partner with a Schedule K-1 (565) that states the partner’s distributive share of the general partnership’s items of income, deductions, and credits even if they are not actually distributed.
The general partnership has no estimated tax requirements. However, California taxes are pay-as-you-go, so partners may have to make estimated tax payments for their own reporting purposes.
- An individual partner’s estimated tax installment payments are due and payable on April 15, June 15, September 15 of the taxable year, and January 15 of the following taxable year.
- Individual partners complete California Form 540-ES, Estimated Tax for Individuals to report their estimated taxes.
- Generally, you must make estimated tax payments if you expect to owe at least $500 ($250 if married/RDP filing separately) in tax for the current year (after subtracting withholding and credits) and you expect your withholding and credits to be less than the smaller of: 1). 90 percent of the tax shown on your current tax return; or 2). 100 percent of the tax shown on your prior year tax return including Alternative Minimum Tax (AMT).
- Each partner is responsible for paying taxes on his/her distributive share even if it is not actually distributed.
General partnerships must withhold 7 percent on distributions of California source income made to domestic nonresident partners when distributions to a particular partner exceed $1,500 for the calendar year.
If the general partnership pays a nonresident independent contractor for services performed in California, normally, the general partnership must withhold 7 percent on all payments that exceed $1,500 in a calendar year.
If the general partnership is required to backup withhold for the Internal Revenue Service, it must also backup withhold for the Franchise Tax Board on California source income. Backup withholding applies to California residents and nonresidents who do not provide a taxpayer identification number or do not certify exemption from backup withholding when required.
For more information about partnership withholding, refer to FTB PUB 1017, Resident and Nonresident Withholding Guidelines.
How to End a General Partnership
- File California Form 565 for all required tax years (including any delinquent returns) and pay all outstanding tax liabilities, penalties, and interest.
- If the general partnership filed a Statement of Partnership Authority (Form GP-1) with the Secretary of State, it should complete a Statement of Dissolution (Form GP-4) and file it with the Secretary of State. This will put the public on notice that the partnership has been dissolved.
- Notify all creditors, vendors, suppliers, clients, and employees of the general partnership’s intent to go out of business.
- Close out business checking account and credit cards.
- Cancel any licenses, permits, and fictitious business names.
- Consider publishing a statement in a local newspaper of general circulation near the general partnership’s principal place of business that it is no longer in business.
Liability of Partners
The General Partnership creates more liability for the partners than any other business entity, so this entity should be used only after careful consideration.
The process of setting up general partnerships may seem daunting… but, it doesn’t have to be.