It is commonly said that a partnership is basically the same as a sole
proprietorship except it has more than one owner. While essentially true, this
basically understates the ramifications of choosing to share ownership.
Combining your resources with a partner can make it easier to get your business
off the ground, but it also complicates matters in many important ways. If you
form a partnership, you become personally liable for the business decisions
your partner makes. If your partner starts engaging in bad business deals and
then leaves town, you will be left holding the bag. There are also other
negative consequences to forming a partnership. It is very easy to get into a
partnership, but if things don't work out or if a partner dies, getting
out of it can be expensive and time-consuming.
Similar to a sole proprietorship, income in a partnership flows through to
the individual partners and is taxed as personal income at their individual tax
rates. Partners report income to the IRS by filing Schedule K-1.
Partnerships work best in situations where two people need to pool their
resources to acquire an asset such as a building. For instance, two dentists
could purchase a medical building together that contains two separate clinics.
They would form a partnership to share ownership of the building, but each
would form their dental practice separately.
When forming a partnership, it is strongly recommended you hire a lawyer to
draft the agreement. As part of the process, sit down with your partner and try
to come up with every possible scenario, both good and bad, that could affect
the business. Then put it all in writing.