By: Irina Moyseyenko, CPA, MT and Kim Racer Robinson, EA
You’ve been offered an opportunity to invest in a partnership; or perhaps you’ve been promoted to partner at your law, accounting or architectural firm. After spreading the good news to everyone, you come to grips with the great unknowns. What does it mean to be a partner? How will my financial life change? Below, we review a few things to consider before signing on the dotted line.
Know the Financial Shape of the Entity
If you buy into a business partnership, you become an owner. As a potential owner, you should know what the business owns, how much it owes, and how it generates cash flow. Review the partnership’s books and records, especially the financial information, to determine its financial health. Review the sources of income and significant expenses, the cash flow from the business, and the partnership’s liabilities. Consider asking for the previous three (3) years of financial information to help you determine financial growth, decline, and/or stability.
Review the Agreement
Every partnership should have a partnership agreement detailing the terms of partnership ownership. The partnership agreement should designate a trusted person who will make everyday decisions on behalf of the business. However, the agreement is mainly used when there is a disagreement or an extraordinary event, such as death or termination of a partner. Think of the partnership agreement as your guide when something goes wrong. Read the entire document; focus on the sections that address termination of a partner, death of a partner, dissolution of the partnership, and your responsibilities if the partnership cannot pay its liabilities.
Types of Partners
Partnerships can have different type of partners, such as those who receive a fixed amount of income every year, or those who share in the overall profits (and losses) of the business. If you share in the overall profits, know how much will be allocated to you. The allocation of partnership profits may differ from the allocation of partnership losses. The type of partner you are to become should be spelled out in the agreement.
Taxes and Liabilities of Being an Owner
Your personal financial and tax situation may change. As a partner, you are taxed on your share of partnership income. The partnership may distribute earnings (but not necessarily cash) to you, but you are liable for the tax. Taxes are not withheld as if you were an employee. You may need to make quarterly estimated tax payments for your federal and state tax liabilities. In addition, you may need to file tax returns in every state the partnership operates (whether you personally worked there or not). This may trigger additional state estimated tax payments. Ask if the partnership files composite state tax returns or withholds nonresident state taxes for any states in which it operates. And, then, talk to your tax advisor. This stuff gets complicated quickly.
Consider if the partnership agreement limits each partner’s liability if lawsuits occur against the partnership. Consider obtaining a personal umbrella insurance policy as well as re-titling certain personal assets for additional protection.
Financing Your Buy-In
Depending on your personal financial situation, you may borrow money from a bank to purchase your partnership interest. The partnership may allow you to contribute capital over time or reduce your future cash distributions to pay for your interest. Again, review the partnership agreement to determine the options available to you. A discussion with your financial advisors may also uncover some other options for financing your buy-in.
Have a Team of Experts at the Ready
As noted above, consider engaging an independent attorney to review the partnership agreement and a trusted tax advisor to review the provisions dealing with finances and tax. You may not be permitted to change the partnership agreement or the terms of the purchase, but at least you will be prepared and aware of possible shortcomings of the agreement.
We Are Here to Help
The Tax Warriors® at Drucker & Scaccetti have experience working with individuals to review their options and help them understand their obligations as a new partner. Our highly skilled advisors can help you assemble a team to assess if you are buying into a financially stable partnership while protecting your assets and limit your liabilities. Call on us when considering entering a partnership. We are always prepared to assist.