What it is:
A partnership is a business structure in which the owners (partners) share with each other the profits and losses.
How it works (Example):
A partnership is organized to provide for proportional ownership of a company among the partners based on some type of formula or value of investment in the company. Partnerships pass along the profit (and losses) to its owners and offer tax advantages to the company. The partnership, itself, for example, does not incur taxes on its profits before the profits are distributed to the partners. Each partner in the partnership pays taxes on the distributions based on their individual tax rate. At the same time, with the liability shield of a corporation, partners may be exposed to a greater degree of personal liability in a partnership.
Additional forms of partnerships have been developed which limit the extent of partner’s liabilities. Limited partnerships which give partners protection from liability and, at the same time, limit their control of the company. A limited liability company gives some, but not complete protection from liability and allows the partners to maintain control over the company.
Also, not all partners are equal. General partners, for example, usually have direct control over the operations of a company. With that control, general partners have joint and several liabilities. Limited partners, on the other hand, have liabilities that are limited to their investment in the partnership.
Why it Matters:
In most legal systems, a partnership is a legal form of a company in which all partners, to some extent, are personally liable for its debts and obligations. Because the partnership itself does not pay income taxes, it passes that obligation to individual partners. As a result, partners are liable for taxes of the profits from their share of the partnership. Also, if it is applicable, partners must file estimated taxes on their share, showing income and deductions, on a quarterly basis.