How to Dissolve a Partnership Agreement

The process of dissolving your partnership

Although the process of dissolving your partnership isn’t as simple as ceasing operations and closing up shop, it doesn’t have to be overly complicated, either. Before you sign a partnership agreement, ensure your agreement includes a dissolution clause to help ease the process. Some of these clauses even include specific procedures that must be followed.

When a partnership dissolves, the individuals involved are no longer partners in a legal sense, but the partnership continues until all debts are settled, the business is legally terminated and the remaining company assets are distributed. [Read more about strategic partnerships.]

If you do not have a predetermined dissolution procedure, follow these steps to dissolve a partnership agreement:

1. Discuss the terms and issues. Sit down with your partners and discuss the terms of the dissolution. If you and your partners disagree on certain issues, you can ask an impartial third party or legal counsel to mediate.
2. Draft a dissolution agreement. Vote on your decision, and draft a dissolution agreement, which will set out the agreed-upon termination terms. Document your individual votes for dissolution.
3. Double-check the terms. Before you sign the agreement, ensure everything you’ve agreed upon under the terms of the partnership is complete and nothing remains outstanding.
   
   • Terminate any outstanding permits, business licenses and other business registrations. 
   • Notify creditors and all local and federal tax agencies about your dissolution, and make sure you file your business’s final tax return and cancel your tax accounts and ID numbers. 
   • Examine any contracts, leases and other business agreements potentially affected by your dissolution. Some contracts will dissolve along with your partnership, but some may stay in place and require certain terms to be carried out.
   • Close out your business bank accounts.
   • Limit any liability that your partners could bind you to for future debts or obligations.
4. Check your state’s business laws. Your state’s laws will govern your partnership dissolutions. Your secretary of state’s office or website should have information on the process of partner dissolution, any relevant termination fees and required forms.
5. File a statement of dissolution with your state. This process can take up to 90 days.
6. Notify all of your customers, clients and suppliers directly. While your state may require you to publish a public notice of your dissolved partnership, deliver the message to the people directly involved in your business.
7. Divide the remaining assets. After all business debts and obligations have been settled, you and your partners should divide any remaining assets. 

Types of dissolution agreements

There are a few types of agreements that govern how your business partnership or LLC can be dissolved without creating additional acrimony among the partners.

Agree to dissolve

If your partner(s) has lost interest but you have not (or vice versa), you can buy out the other partner’s (or partners’) shares.

Buy-sell agreements

A buy-sell agreement clearly spells out who can and cannot buy into the business if you or your partners sell out or declare personal bankruptcy, or in the event of death, divorce or disability. With such an agreement in place, the remaining partners are protected against unwanted partners buying into the business or divorced spouses wanting a part of the business.

New dissolutions

If you and your partner mutually decide to end the business venture, a partnership dissolution agreement can help you agree on the terms of dissolving the partnership. A dissolution agreement specifies the duties of each partner. It also establishes timelines for ending the partnership and the roles of each partner in the process. Entering a partnership dissolution agreement does not immediately end the partnership. You still have to settle debts, legally terminate the business and distribute any assets of the partnership.

Statement of dissolution

Once you and your partners agree on the terms of dissolving your company and all dissolution proceedings have ended, you must file a statement of dissolution. The instructions for completing a statement of dissolution vary from state to state. You might be required to pay any back taxes when you file a statement of dissolution. The IRS also has a checklist of to-dos.

The effects of ending a partnership 

Ending a partnership has multiple effects, many of which involve taxes. However, it can also take a toll on you, your business and all those involved.

Tax effects of ending a partnership

A partnership is not a tax-paying entity; profits and losses are passed directly to the partners, who are not considered employees of the business. Therefore, dissolving a partnership comes with multiple tax implications. Here are just a few of the impacts that ending a partnership could have on your taxes:

• Legal obligations per your contract: Examine the partnership agreement to identify specific tax-related provisions and obligations for dissolution. It can be helpful to consult a tax professional during this process.
• Tax forms for your partnership and business: If you dissolve a partnership before the end of the tax year, you’ll need to file Form 1065. Depending on the circumstances, you also may need to file Form 4797 (for sold or exchanged business property) and Form 8594 (if the business is sold).
• Final tax filings for each partner and any employees: At the end of the partnership, you’ll need to complete all required final tax filings, including the final partnership tax return and Schedule K-1 forms for each partner for their share of income, deductions and credits. If the partnership had employees, you will need to make final federal tax deposits. Failure to withhold taxable income for Social Security and Medicare could result in penalties, such as the trust fund recovery penalty.

Additional effects of ending a partnership

Beyond the legal and financial complexities, ending a business partnership can take a significant toll on your business operations and relationships. Here are some aspects of the business that may require your attention:

• Partner relationships: Even on the best terms, ending a business partnership can strain the relationship between both parties. Review the partnership agreement or LLC operating agreement to understand the exit strategy, asset division and obligations. When you’re negotiating a business dissolution, clearly define and communicate your desired outcomes to collaborate effectively with your partner toward mutually beneficial goals.
• Business structure: After a partnership ends, the business structure often needs to be adjusted, which involves navigating regulatory requirements and possibly tacking on more legal costs. This can have a ripple effect on employees, whose job titles, responsibilities and day-to-day experience can be affected. Be transparent about any changes, and be prepared to answer any questions from your team.
• Brand reputation: Your customers may have concerns about the change. Striving for an amicable dissolution and communicating clearly with your stakeholders can help preserve client relationships and protect your future endeavors. Additionally, resolving any disputes through mediation can help avoid costly litigation and protect your business’s reputation. 

Can a dissolved partnership be sued?

Yes. Even though the partnership is dissolved, you and your partner(s) can be sued during and after the dissolution process under certain circumstances.

If your general partnership entered contracts with other individuals or businesses, you and your partners can still be held liable after dissolution. If those contracts don’t include terms that absolve you and your partners of a breach if the partnership is dissolved, your partnership as a whole (or each individual partner) can be sued even after dissolution.

Julianna Lopez contributed to this article.