Partnership Lost

A century ago, two distinct business entities existed that could best be defined by describing either one of them as simply not the other. The corporation and the general partnership were mirror images of one another and opposites on a spectrum of corporate governance, limited liability, and taxation. Partnerships, seen as small, livelihood enterprises between active-owner partners, had personal liability but pass-through taxation. Corporations, seen as larger, capital-intensive enterprises with passive-owner shareholders, had limited liability but double taxation. The tax distinctions survive today, but the stereotypical partnership does not; in fact, the modern partnership is more corporation-like than partnership-like. Today, the corporation-partnership dichotomy has disappeared. “Tax partnerships” for federal tax purposes can be formed under various state statutes that mimic closely the traditional corporation: centralized management; freely transferable shares; limited liability; perpetual life; and even elimination of fiduciary duties. In response to requests by various constituencies, state legislatures have spent the past few decades creating hybrid business entities that boast the best characteristics of both corporations and general partnerships. As state lawmakers made the pass-through entity more corporation-like, federal lawmakers conceded the fight on which entities could have pass-through taxation. Now, any noncorporate entity receives pass-through taxation as a default classification, and even publicly traded partnerships with thousands of “partners” may qualify. The hybrid entity is more corporation-like than the corporation, for which nonwaivable duties still remain. However, in December 2017, Congress passed and President Donald J. Trump signed the 2017 Tax Cuts and Jobs Act into law. This legislation, arguably the first major piece of tax legislation since 1986, reduces the top corporate tax rate, decreasing the “double tax” on corporate profits to nearly equal the partnership tax rate. The 2017 tax reforms present a perfect point in time to study why hybrid entities have gained in popularity so swiftly. Are these entities popular because of the freedom of the parties to contract for optimal governance mechanisms, mimicking the best parts of corporate governance without drawbacks of fiduciary duties? On the other hand, the popularity of the hybrid entities may be merely economic, based on these entities tax advantages. If entity tax rates have converged, perhaps federal taxation should rethink whether two types of entity taxation is necessary at all or, in the alternative, whether passthrough taxation should be granted to entities based on criteria other than state law classification, such as size, active ownership, or limited liability

Startup Partnerships

Every business firm that is created must be categorized as some type of entity from the moment it begins to have value, either positive value or negative value. For many firms, the entity is simply a sole proprietorship. But if there is not a “sole” owner, then the entity must be something else, and if the owners have not incorporated as a corporation, limited liability company, or limited partnership, then that “something else” is a general partnership. In this way, the most important law that governs startup companies may in fact be partnership law. Through the application of state partnership law to a nascent venture, parties will have the right to an equal share of profits if not specified, have the right to co-manage the venture, and owe fiduciary duties to one another, including the duty of confidentiality and the duty not to compete with the venture. Most disputes that arise in which one party alleges an informal partnership involve relatives, former romantic partners, or acquaintances in small businesses. Some of these informal partnership cases, however, involve joint ventures between business giants and even billion-dollar technology startups. Though parties may find it surprising that the business idea they have been working on with acquaintances, friends, or even competitors is a general partnership, the legal doctrine that compels this result preserves expectations, protects the vulnerable from opportunistic venturers, and encourages entrepreneurship and information sharing