This is a type of business entity that is still very common in the US. There are two million of partnerships in the United States. They generate 2 and a half trilliard dollars. One of the consequences of a partnership is that all of the partners are personally liable for the debts and obligations of the partnership. All of the partner’s personal assets areexposed to potential recovery for debts against the partnership. For that liability, it doesn’t matter that the partner personally acts in the act that causes the obligation or signs the contract. It is another example of vicarious liability.
If you are a partner, you are giving a guarantee to anybody who deals with the partnerships that you will be liable. If you are a partner, you give apersonal guarantee. That is a huge risk. On the other hand in a corporation, owners of the corporation, the shareholders are protected by limitative liability shield.
The liability is limited to the amount of the participation.
Given that difference, why will anybody become a partner then?
Partnerships have tax advantages:
A corporation is a taxable entity, which meansthat a corporation pays taxes in its own name. As a consequence, corporate profits are subject to double taxation: they are taxed when the corporation reports them as incomes and when they are distributed to shareholders. This is significant if we are talking about a small business. Traditionally one way to avoid this is a partnership because a partnership is not a taxable entity: it is apass-through entity. The income is not taxed at the level of the partnerships. The partner will pay tax on that income. The partnership has to file a tax return (return = declaration of income) but only for information purpose (to inform the Internal Revenue Service). All they have to show to the IRS (Internal Revenue Service) is how much income the partnership earned and how it is divided between thepartners. Any loses of the partnership pass-through to the individual partners and can be used as up-set. The corporation pays taxes on its profits and those profits will be distributed to shareholders (dividends). Dividends received are taxable income for the individual. It is been taxed twice. It is not painful if you are a shareholder in a large corporation.
That traditional advantage has lostits appeal for a couple of reasons:
In the 1990s, it has been possible to do business in a new way: limited liability companies LLC and limited liability partnerships LLP. They combine limited liability to the owners of the business while preserving possibility of having the income passed directly to the owners, taxed once. It was half-partnership and half-corporation: limited liability of thepartnerships and the entity is taxed as a partnership. They become very popular. The IRS accepted this form of entity recently. Since that limited liability entity became legal, less advantage for partnerships.
In 2003 Bush submitted to Congress and Congress admitted it a tax reduction Act: a tax reduction act was passed which reduced the tax rate on dividends. The rate fell from 38.6% to 15%. Thedouble taxation became less painful. It was created to expire in 2008. But in 2006, the measure was extended until 2010. It was one of the issues raised during the presidential election: it is criticized because people say that it is a privilege for the rich because the rich have dividends.
Traditionally, certain types of profession did not have the option of incorporating
The “learnedprofession” such as lawyers, doctors, dentist… Because of all of this learning, they hold a special responsibility to the public so it was not appropriate that their liability is limited. They could only do partnerships.
In the 1970, it changed. A new creature was created: “profession corporation”. The limited liability was accepted.
Flexibility and cost
To become a corporation, the business...