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How to Dissolve a Partnership Agreement

Updated Aug 10, 2023

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When entering into a business partnership, it’s easy to get swept up in the possibilities of your new venture and overlook the possibility that the partnership may not work out. 

Establishing a business partnership or limited liability company comes with many risks, and if those aren’t managed correctly, it could result in the dissolution of a partnership, damaged relationships and potential lawsuits

Before you go into business with a partner or partners, it’s important to have a signed partnership agreement in place. Make sure you know how to properly dissolve a partnership agreement in the event one or more of the partners loses interest in the business, if conflicts arise that can’t be resolved, or the business fails.

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 legal existence of the business is terminated and the remaining assets of the company have been distributed. [Read more about strategic partnerships.]

If you do not have a predetermined dissolution procedure, here are the steps to dissolve a partnership agreement:

  • Discuss terms and issues. Sit down with your partners and discuss the terms and the issues of dissolution together. If you find that you and your partners are disagreeing, you can ask an impartial third party or legal counsel to help mediate. 
  • Draft a dissolution agreement. Vote on your decision and draft a dissolution agreement, which will set out the agreed-upon termination terms. Additionally, document your individual votes for dissolution.
  • Double-check the terms. Before signing the agreement, ensure everything you’ve agreed upon under the terms of the partnership is complete and nothing remains outstanding, including:
    • Terminating any outstanding permits, business licenses and other business registrations 
    • Notifying creditors and all local and federal tax agencies about your dissolution; make sure you file your business’s final tax return and cancel your tax accounts and ID numbers 
    • Examining any contracts, leases and other business agreements potentially affected by your dissolution; some contracts will dissolve along with your partnership; however, some may stay in place and require certain terms to be carried out
    • Closing out your business bank accounts
    • Limiting any liability that your partners could bind you to for future debts or obligations
  • 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. 
  • File a statement of dissolution with your state. This process can take up to 90 days.
  • 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.
  • Divide remaining assets. After all business debts and obligations have been settled, you and your partners should divide any remaining assets. 
TipBottom line

To ensure you’re upholding your legal obligations, consult with an experienced business lawyer to navigate state-specific rules for dissolution.

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 into 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.

Types of dissolution agreements

There are a few different agreements you want in place that govern how your business partnership or limited liability company 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), as a partner, 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 should 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, remaining partners in the business are protected against unwanted partners buying into the business or divorced spouses wanting a part of the business.

New dissolutions

Should you and your partner mutually want to end the business venture altogether, a partnership dissolution agreement can help you agree on the terms of dissolving the partnership. A dissolution agreement specifies the duties of each partner, and it establishes timelines for ending the partnership and the roles each partner will play in the process. Entering into a partnership dissolution agreement does not immediately end the partnership. You still have to settle debts, legally end 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 then must file a statement of dissolution. The instructions for completing a statement of dissolution vary from state to state. You might also be required to pay any back taxes at the time you file a statement of dissolution. The IRS also has a checklist of to-dos.

Bottom LineBottom line

There are multiple types of dissolution agreements you can put in place to dissolve your business amicably. Go through each option and determine which agreement works best for you and your partners’ situation.

The effects of ending a partnership 

Deciding to end a partnership is never easy, and to further complicate matters, there are a lot of steps involved in dissolving one. Ending a partnership has multiple effects, many of which involve taxes. A partnership is not a tax-paying entity, as profits and losses are passed directly to the partners, who are not considered employees of the business.

If you dissolve a partnership before the end of its tax year, you and your partners must file Form 1065. Additionally, according to the IRS, in the event of a partnership termination, you might also need to file Form 4797, if any property used in the business has been sold or exchanged, and Form 8594, if you sell your business. 

You and your partners may also have a taxable gain on any money or assets received upon the termination of the partnership or share a loss that will reduce your taxable income. Taxable gains are recognized only if the gain a partner receives is greater than their total investment in the business. Taxable gains include leftover profits and liquidation of assets. Establishing these gains and losses can be complicated, so it is best to consult a tax advisor.

If your partnership employed one or more workers, you must make final federal tax deposits. If you don’t withhold taxable income for Social Security and Medicare, the trust fund recovery penalty may apply to the full amount of the unpaid trust fund tax.

Consult with an attorney who specializes in commercial law when dealing with a business or partnership dissolution. Knowing what to expect can give you greater decision-making power and the ability to move forward confidently with peace of mind. 

Additional reporting by Julianna Lopez.

Sean Peek
Senior Analyst & Expert on Business Ownership
Sean Peek has written more than 100 B2B-focused articles on various subjects including business technology, marketing and business finance. In addition to researching trends, reviewing products and writing articles that help small business owners, Sean runs a content marketing agency that creates high-quality editorial content for both B2B and B2C businesses.
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