"A wise person should have money in their head, but not in their heart." – Jonathan Swift

Your dreams of being the boss aside, your business isn’t going to last long if you don’t handle your money right. If your business is a partnership, you have special considerations – such as how your business is structured and (much, much more importantly) how everybody gets paid in business partnerships.

It’s key to set up your company so everyone knows how the money flows. 

Basics of the money roadmap

First, let’s pin down what kind of partnership you have. The type of partnership can influence how the money flows within the company. Bear this in mind whether you’re an established company or just considering your first business partnership. 

Three common arrangements for business partnerships are: 

General Partnership: All partners share equal rights and responsibilities. This is the easiest partnership to form with relatively few startup costs and simpler taxes, but partners assume unlimited liability for obligations of the partnership. 

Limited Partnership: This comprises general and limited partners. Both get a cut of the profits but have different jobs and liabilities. Limited partners, aka silent partners, contribute capital to the partnership but don’t manage daily operations.

Limited Liability Partnership (LLP): Each partner chooses how much they’d like to invest and their level of involvement. All LLP partners are essentially general partners but with limited liability. Some states restrict who can be an LLP and registration and filing requirements are stricter. 

Ways to split the take in business partnerships

Profit-sharing is a common method of paying partners. You can share the profits equally or you may decide to pay each partner a set salary and then divvy up any remaining profits. Revisit your profit-sharing plan frequently, by the way – it can go out of date in the eyes of at least one partner awful quick, and that’s trouble. 

A partner’s stake in the company, aka their capital account, is a record of initial and subsequent contributions (cash or other assets) and what that partner has received from your company’s profits and losses according to the partnership agreement. Partners usually don’t receive a regular paycheck, but some may receive a guaranteed payment that’s unconnected to their partnership share and that isn’t dependent on how the partnership does financially. 

Partners do get what’s called a “distributive share” of the profits and losses of the business each year. Payments are made based on the partnership agreement – an important document, as we’ll see – and the partners are taxed individually on these payments. A distributive share is based on the net income of the business or if you own part of an S Corporation, your percentage of the shares. If you don’t have a partnership agreement, each partner’s distributive share is based on their ownership based on capital contributions, interests in the economic or taxable income of the partnership, and rights of partners to assets if the partnership is liquidated. 

Of course, make sure the split totals 100% and that every partner agrees in writing to the division. 

New partners can also disrupt the money arrangements. You may need to reform your partnership (remember to rewrite your agreement). New partners can also buy another partner’s share or receive a bonus if they’re bringing a profitable asset or client base to your company. 

Suppose one of your partners wants to pull up stakes? Your remaining partners can buy out the leaving partner and take control of his or her shares, they can pay out the value of that partner's capital account and include a cash bonus. The departing partner can pay a bonus to the remaining partners by not fully cashing out their capital balance, which gets split among the remaining partners. 

Get it in writing

You’ll want to detail your partners’ relationships with your partnership agreement. It should include each partner’s information, profit and loss distributions, initial contributions and percentage of ownership, each one’s decision-making authority, the management structure (including each partner’s duties), and a description of operations (including the type of partnership). It should also detail what happens to a share in the event of a partner’s death. 

As with your profit-sharing agreement, revisit it frequently. 

Tax planning

Business partnerships do file an annual information return to report the income, deductions, gains, losses, and so on from operations but they do not pay income tax. You do: The partnership “passes through” (pass-through entity) profits or losses to partners and each reports their share of the income or loss on their personal tax return. Don’t let this be a surprise if you haven’t filed taxes as a partner before.

Partners don’t get the employees’ Form W-2. Instead, your partnership will give you copies of Schedule K-1 (Form 1065). If you’re a general partner, you may also plan to pay self-employment taxes. Limited partners must pay SE (Self Employment) taxes only on guaranteed payments.

Get things right in your business partnership. Make sure the money is flowing to the right people. 

BE THE ROAR not the echo®

Janet Behm
Utah Real Estate Accountants
(801) 278-2700