The IRS automatically considers any business started by more than one person a partnership, and must report their finances as such. Each person in the partnership is equally liable for the activities of the business, but because more than one person is involved, a partnership is a slightly more complicated company type than a sole proprietorship. Partners have to sort out the following legal issues:
How they divide profits
How they can sell the business
What happens if one partner becomes sick or dies
How they dissolve the partnership if one of the partners wants out
Because of the number of options, a partnership is the most flexible business structure for a business that involves more than one person. But to avoid future problems that can destroy an otherwise successful business, partners should decide on all these issues before opening their business's doors.
Partnering up on taxes
Partnerships aren't taxable entities, but partners do have to file a “U.S. Return of Partnership Income” using IRS Form 1065. This form, which shows income, deductions, and other tax-related business data, is for information purposes only. It lists each partner's share of taxable income, called a Schedule K-1, “Partner's Share of Income, Credits, Deductions, Etc.” Each individual partner must report that income on his or her personal tax return.
Reporting requirements
Unless a partnership seeks outside funding, its financial reports don't have to be presented in any special way because the reports don't have to satisfy anyone but the partners. Partnerships do need reports to monitor the success or failure of business operations, but they don't have to be completed to meet GAAP standards.
Usually, when more than one person is involved, the partners decide among themselves what type of financial reporting is required and who's responsible for preparing those reports.
If the partnership seeks funding from a bank or investors, more formal reporting may be needed, such as audited financial statements and business plans.
