Do I need a Partnership Agreement?

March 27, 2026 by Glynis Miller, CPA, MST

When starting a new business, one of the early decisions made is the entity's business structure. The type of business structure will dictate how the business operates and the tax treatment of the various business transactions. The following are the operational structure options for which a business can be set up:

• Sole Proprietorship, 
• Partnership
  • General Partnerships (GPs)
  • Limited Partnerships (LPs)
  • Limited Liability Partnership (LLPs)
  • Limited Liability Limited Partnerships (LLLPs)
• Limited Liability Company, 
• S Corporation, or 
• C Corporation.

No matter which business structure is chosen, the key is to ensure it is set up correctly and that all required legal documents are completed and timely filed, when necessary. For example, creating a corporation requires filing articles of incorporation with the state in which you are forming the entity. With that in mind, please note that many of the listed business structures will create a separate legal entity from the owners. This is why most of them require formal written documentation to establish their formation. The exceptions are the sole proprietorship and the general partnership. 

Given that most business entities require formal written documents, it is understandable that the question arises: Is a written partnership agreement needed? 

In short, like a sole proprietorship, a general partnership can be formed without a formal written partnership agreement. However, it is worth noting that just because a written agreement is not required does not mean it is a good idea to forgo putting everything into writing.
 

How does a partnership work in general terms?

It is important to first understand how a partnership functions to appreciate why a written agreement, although not required, may prove to be the smartest thing to do. The formation of a partnership does require at least two parties to come together to conduct a trade or business, but there can be many, many more partners. The more partners involved, the more crucial it becomes to put things in writing.

These individuals operate the trade or business, usually under a partnership name, but the partnership is not treated as a separate entity for tax purposes. The partnership is considered a “pass-through entity.” In other words, each partner will generally be taxed as a self-employed individual, with the taxable or deductible items being passed through and reported on personal tax returns. 

Although a partnership is not a separate entity for tax purposes, a partnership tax return is filed to report the results of operation. Thus, the partnership tax return is considered an informational return. Each partner should receive a copy of the return, which will include a K-1 that identifies the profit or loss, capital gains, or other items that pass through to the individual. Without a written partnership agreement, the partnership's tax treatment could default to the state's statutory rules, even if the partners discussed other terms.
 

Why should you put a partnership agreement in writing?

Partnerships are generally governed by the Uniform Partnership Act (UPA) and the Revised Partnership Act (RUPA). As noted, without a written partnership agreement, tax treatment defaults to the provisions outlined in these statutory rules. As a result, profits and losses would typically be split equally among the partners (capital contributions are not taken into account). Under these provisions, the right to manage is split equally as well, with no partner permitted to receive a salary. Also, the partnership's liabilities or debts will be joint and several, meaning that if one partner does not pay their share, the other partner(s) will be responsible for paying the debt.

For example, if the two partners discussed splitting profits 75% and 25% respectively but did not put it in writing, they may be forced to split the profits and losses equally (50%-50%). Depending on their respective contributions (financial or time working in the partnership), an equal split may not be equally advantageous to both partners. While this is just a simple example, it only scratches the surface of why putting everything in writing can be beneficial.
 

How are profits or losses split?

The splitting of profits or losses can be done based on any of the following methods:
 

• 50/50 Split – each partner receiving profits or losses equally. 
• Ownership Interest – the percentage of ownership each partner has in the partnership (generally tied to capital contributions to the partnership).
• Performance split – the split is based on each partner's time/effort in the trade or business activity.

These are just a few of the ways profits or losses can be split, but they may not cover every option. Keep in mind that the more complex the profit or loss splitting conditions, the greater the need to put the partnership agreement in writing.
 
Note: The term 50/50 split is most often used because a partnership requires only two individuals to form it. However, it is important to remember that if there are more than two partners, the split remains equal among all of them. For example, if there are 5 partners, then each partner would receive a 20% split. Likewise, if there were 4 partners, each would receive a 25% split.
 

How do the contributions of a partner impact ownership?

Partnerships, for all intents and purposes, are relationships, and a common consideration when thinking about relationships is what each partner brings to the “table.” Each partner brings something to the table during the formation of the partnership. Whatever they bring to the partnership is considered their contribution. 

The simplest example of a partnership contribution is cash. If Partner A and Partner B each contribute $100,000 to the partnership, they are equal partners. Why? Because total contributions are $200,000 and they contributed equally, they are 50/50 partners. 

On the other hand, if total contributions were $200,000, with Partner A contributing $150,000 and Partner B contributing $50,000, then they are not equal partners. Instead, Partner A owns 75%, and Partner B owns 25%. For these partners, a written agreement would be necessary to ensure they receive their fair share of the partnership's profits and losses. 

While the simplest form of contribution is cash, partners can also contribute other forms of property. When property is contributed, it is generally not a taxable event. Meaning that neither the partner nor the partnership has a requirement to pay taxes on any gains from the transaction. Instead, these contributions create what is known as a partner's basis in the partnership for tax purposes. As such, any additional contributions will increase the partner's tax basis.

It is important to note that, even if the contributions indicate a specific ownership interest, the partners can still agree to split profits/losses differently from the ownership interest. However, if they fail to put that in writing, they may be forced to accept the state's statutory limits.
 

How do the distributions of a partner impact ownership?

Like contributions to a partnership, distributions generally do not result in a taxable event. If we think of that same table we discussed in relation to a partner bringing something into the partnership, a distribution is like the partner removing something from the table. 

Again, the simplest example of a distribution is cash, and when a partner withdraws cash from the partnership, it is generally considered a distribution or a draw. Please note that if equipment or property is withdrawn or distributed from the partnership, it could trigger a taxable event. Thus, prior to distributing any property from a partnership, you should talk with your tax professional to avoid any unexpected tax consequences. 

Just as a contribution increases a partner's basis, distributions can reduce it. Keeping track of a partner’s tax basis is crucial, as it determines when a partner can take any partnership losses on their individual tax returns.
 

Are partners paid any compensation?

Partners are not paid a salary or wages for their services; instead, they receive the profits of the business. As previously noted, partnerships are pass-through entities, meaning that profits and losses flow through to each partner. At the end of each reporting period, the recorded results of operation are allocated to each partner, with each partner being personally responsible for reporting the profits or losses (if deductible) on their individual tax returns. 

In situations where one of the partners may be providing significant intellectual property or physically working in the partnership, they could be compensated with guaranteed payments. A partner could receive guaranteed payments regardless of whether the partnership has a profit.
 

What are guaranteed payments, and how are they treated?

The following are components that describe guaranteed payments:
 

• Fixed amount
• Predetermined
• Paid by the partnership 
• Paid to a partner for services rendered 
• Paid regardless of the income/profits of the partnership
• Deductible as a partnership expense 

Guaranteed payments are treated as partnership expenses, payable to certain partners under agreed-upon terms. A guaranteed payment is a deductible expense reported on the partnership tax return. It is deducted along with other operating expenses; thus, it is used to determine the business profits or losses for the year. Guaranteed payments are not considered distributions from the partnership, as distributions are not deductible by the partnership. Likewise, a distribution is generally not taxable to the partner, but a guaranteed payment would be taxable.

Remember, a partnership does not have to earn a profit in order to pay guaranteed payments. On the contrary, as previously noted, guaranteed payments, when paid, are used to determine the partnership's profits or losses. Because guaranteed payments are part of determining profits and losses, they are not tracked as part of a partner’s basis in the partnership.

 

What happens to out-of-pocket expenses paid by a partner?

It is not uncommon for a partner to pay for some of the partnership's business expenses out of their own pocket. These expenses, if not reimbursed, may be considered non-deductible if there is no agreement among the partners on how to treat them. 

For example, the partner could seek reimbursement from the partnership, which would result in the expenses being reflected in the year-end results of operations. If the partner does not seek reimbursement, they may include the expenses on their individual tax return as unreimbursed business expenses (UPE). Of course, to report them, the partnership agreement must indicate that a partner is expected to make such payments out of pocket. Without an express requirement to pay these expenses, these items are not deductible personally. 

When a partner is allowed to deduct UPE, they can essentially reduce their taxable partnership income. While there is no specific requirement that the terms be in writing, having them in writing will ensure they are followed correctly and serve as evidence of the partners' clear intentions.
 

How are Profits/Losses of the partnership treated?

The profits and losses of the partnership are recorded in the partnership’s informational tax return (Form 1065 – U.S. Return of Partnership Income). As part of the partnership return, a Schedule K is included to report the partner’s distributive share items. Schedule K reports the aggregate amounts of the partnership, and each partner receives a Schedule K-1 that represents their distributive share of each specific item. 

Whether you are preparing your own individual tax return or using a tax professional, Schedule K-1 will provide much of the information needed to report on the activities of the partnership. If your Schedule K-1 shows a positive amount as ordinary business income, it reflects your portion of the partnership's taxable income and should be reported on your personal return.

On the other hand, if it shows a negative amount that is reflective of your portion of the partnership's losses, you will need to determine if you have sufficient tax basis in your partnership to allow the deduction of the losses.
 

What happens if a partner passes away?

If you have a partnership with two partners and one partner passes away, the partnership generally ceases to exist. Although the business itself may continue operating, legally the partnership activity has ended, triggering specific tax reporting requirements. 

For example, the partnership's tax year would end on the date of the partner's death. Without an agreement, the remaining partner may be able to continue the business, but it would no longer be operating as a partnership, requiring the filing of a final partnership return and other liquidation actions. This can be avoided if the partners have addressed this in the partnership agreement. 

Within the partnership agreement, the partners can arrange for the partner's ownership interest to transfer to the partner’s estate upon the partner's passing. In doing so, the partnership can generally continue operating without requiring any liquidation. 

In situations where there are more than two partners, the passing of one partner can still result in the end of the partnership tax year unless there is some type of buy-sell agreement or continuation clause.
 

What happens if one partner wants to sell their interest?

There can be many reasons a partner may decide they no longer want to own an interest in a partnership. To avoid any unwanted or unforeseen tax implications, the partners may want to include a formal Buy-Sell agreement/Continuation Clause in their partnership agreement.

The Buy-Sell agreement, or Continuation Clause, will be legally binding on all partners and will provide specific formulas that allow for the buyout of any partner wishing to leave, including a deceased partner’s ownership interest.
 

Summary

A written partnership agreement is not required to form a general partnership. But as the above information demonstrates, having one in writing can prove to be very beneficial. The written partnership agreement would provide clear and decisive guidance on how to allocate profits, losses, and capital gains, capital losses, as well as what to do if a partner dies or wants out of the partnership. Additionally, it provides substantiation for the business policy and the treatment of unreimbursed partnership expenses. 

When discussing the terms of the partnership verbally, misunderstandings or differences in interpretation can occur. By putting the partnership agreement in writing, those potential misunderstandings or differing interpretations can be avoided.