Partnership Agreements
The same considerations discussed above concerning Stockholder Agreements apply just as well in the context of a partnership agreement. There are, however, a few additional items which may be addressed via a partnership agreement.
Control
Each of the partners in a general partnership has equal authority to bind the partnership. The Partnership Agreement may provide a different allocation of power. For example, one partner may have managerial authority, while another is passive. Alternatively, unanimous consent may be required to take some or all partnership actions.
As a general rule, if a partner transfers his partnership interest to another person, the transferee will be treated as a mere "assignee". The assignee will be entitled to whatever distributions the partnership may make, but will have no "political" rights and no rights to information. That is, the transferor continues to be a partner for all purposes other than receiving distributions (Fla. Stat. §620.8503). Many partnership agreements provide that the transferee will become a substitute partner (i.e., step into the transferor’s shoes) under certain circumstances, such as with the consent of a majority of the other partners and the transferee’s consent to be bound by the partnership agreement.
Dissociation
Unlike a stockholder or a member in an LLC, a general partner has the right to dissociate (i.e., withdraw) from the partnership at any time (Fla. Stat. §§620.8601 and 620.8602). If the partnership agreement prohibits dissociation (and in certain other events), the dissociation is considered "wrongful", which means the partner is liable for any damages caused by the dissociation.
Whether or not wrongful, if the partnership continues, the dissociated partner has the right to be redeemed for a price equal to what would be distributed to him if the partnership either liquidated its assets or sold its business as a going concern, whichever was greater, and then dissolved. Payment of the price may be deferred until the term of the Partnership has expired. Any deferred payment must bear reasonable interest and be secured.
Many partnership agreements prohibit dissociation, assess liquidated damages in the event of wrongful dissociation and provide for deferred payments and security in the event of a wrongful dissociation.
Book Versus Tax Accounting
As a general proposition, partnerships keep two sets of books. One set of books is for economic purposes (i.e., accounting for the "deal" among the partners) and the other is for tax purposes. Both sets of books rely on an accounting concept called a "capital account."
For "book" purposes, when a partner contributes assets to a partnership, he is credited with a capital account equal to the net value of the contributed assets. His capital account increases as income is allocated to him and decreases as losses are allocated to him and as distributions are made to him.
But tax laws are not so simple. A tax set of books is necessary to keep the partners from arbitrarily shifting items of income and loss among themselves so as to lower their collective tax liabilities without any other economic effect.
Example
Suppose Partnership AB is comprised of two partners, A and B. The partnership is in the equipment rental business. A contributes equipment with a value of $10,000 and B contributes $10,000 cash. Assume A bought the equipment three years ago for $20,000 and that he is depreciating it on a straight line over four years. Thus his basis in the equipment is $5,000. The partners agree to share profits and losses equally.
- Each partner starts with a capital account of $10,000 for book purposes.
- The partnership has a $5,000 basis in its equipment.
- Partner A has a $5,000 basis in his partnership interest.
- Partner B has a $10,000 basis in his partnership interest.
Assume that in year one the Partnership has business expenses which match its income, so that it has a net tax loss of $5,000, all attributable to depreciation of the equipment. The Partnership experienced a $5,000 loss for book purposes, which is allocated $2,500 to each partner via their Partnership Agreement. Thus each partner has a capital account of $7,500 for book purposes.
Who Gets the Depreciation Deductions?
The surprising answer is Partner B, the partner who contributed cash. IRC §704(c) provides that the income and deductions associated with contributed property shall be allocated among the partners so as to eliminate the relative book-tax disparities among the partners as quickly as possible. By allocating depreciation to Partner B, each of the partners ends up with:
- A basis in his partnership interest of $5,000
- A capital account for book purposes of $7,500
Thus eliminating the relative book-tax disparities among the partners.
