Q. When starting a new investment club, should you form as a partnership, corporation or some other entity? What type of entity is the best tax-wise?

A. For most clubs, forming a corporation is way too expensive and complicated to be feasible. NAIC recommends that clubs form as a general partnership. In this type of entity, all tax liability flows through to the partners. The partnership itself does not have to pay taxes, although it does need to file a partnership return with the IRS each year. Each year, also, the individual partners must pay taxes on their share of the capital gains, dividends and income from the club.

NAIC's Official Guide, "Starting and Running a Profitable Investment Club", includes a sample partnership agreement that you can adapt for your own club (you can also find a copy on the NAIC Web Site).

Recently, some states have adopted a new form of business registration known as a Limited Liability Corporation (LLC) or a Limited Liability Partnership (LLP). LLCs and LLPs offer their members protection from certain liabilities, something that's not found in general partnerships. Although NAIC's recommended partnership agreement clearly outlines the activities in which the club is permitted to engage, some people feel that a partnership doesn't provide enough protection of personal assets.

It's my understanding that it's possible that any partner in a general partnership could legally bind the partnership, or that a creditor could come after the assets of other partners if one member has financial troubles. NAIC's agreement is designed to prevent these sorts of things, however. An LLP/LLC in this situation is a bit like wearing a life preserver while sitting in your boat -- while it's parked in your driveway. (Of course, it's quite possible that you could find an attorney who would argue why this is prudent.)

The downside of forming an LLP or LLC is they are more expensive to form and operate than a partnership. Some states assess organizational and continuing fees which can exceed $300 per year. In order to form an LLP or LLC, you'll probably need an attorney to draw up Articles of Organization which will be filed with the Secretary of State in your state (something you probably won't need with a general partnership if you follow NAIC's recommendations)

In general, the general partnership has worked for tens of thousands of clubs, so it's probably the best route for most new clubs.