Question of the Week
Essential Elements of a Partnership Agreement
Happy Friday, all!
I’ve had several conversations this week about Partnership or Shareholder agreements, so it seems like the perfect time to do an overview of these types of agreements.
Many taxpayers get together to form a business and start operating as a partnership without any formal organization. Consequently, partnerships very often have no legal documentation. And while no documentation is required, all partners should consider putting their intentions in writing by establishing a partnership agreement.
Overall, a partnership agreement sets the ground rules for the partnership. When talking about S-Corporations, you’ll hear this agreement called a Shareholder agreement. Either way, it’s usually best practice to have an attorney in the area you are organizing draw up this legal document for you.
Here are some essential provisions to consider:
- Name, location, and business purpose of the partnership
- Name of person responsible for maintaining the books and records of the partnership and where you keep them.
- Business year (calendar or fiscal)
- Profit and loss sharing ratios
- Expectations of each partner
- Designation of the partnership representative
- Choice of accounting method (cash or accrual)
- Capital contributions (money, property, inventory, etc.) required by each partner (includes provisions for raising more capital as needed by the business)
- Conditions for admitting new partners to accommodate for the withdrawal of partners
- A provision to address the death of each partner, such as buy-sell agreements, rights of heirs, and other partners
- Individual responsibility expected by partners for partnership expenses
- Guaranteed payments, withdrawals, and other distributions from the partnership
- Retirement plans and contributions of each partner
- Doing business in another state, licensure, and maintaining professional standards
- Loans to or by the partnership, recourse, or nonrecourse
- Indemnification provisions to protect innocent partners
- Termination of the partnership and liquidation of assets, and requirements to restore a partner’s negative capital account
- Methods to amend the partnership agreement
Remember that the initial agreement doesn’t have to be perfect. You can modify the agreement at the close of the tax year but no later than the due date of the return, not including extensions.
Quote of the Week
“Don’t make assumptions. Find the courage to ask questions and to express what you really want. Communicate with others as clearly as you can to avoid misunderstandings, sadness, and drama. With just this one agreement, you can completely transform your life.” – Don Miguel Ruiz
Task of the Week
Are you running a business without a partnership agreement? Talk to your partners immediately about putting one into place and get on it. Trust me, it will take longer than you think.