When starting a business one of the most important decisions you will make will be what business structure you will operate under. This choice has a wide range of impacts from the filing requirements, to start-up and on-going costs, reporting requirements and tax status to name a few. For small businesses with 2 or more owners the choice of business structure often comes down to evaluating an LLC vs a Partnership. In this business structure comparison, we’ll go over what an LLC and partnership are and the 3 key areas of difference between the two business structures. If you are looking for a more comprehensive guide to choosing the best business structure type that includes all 4 business structures check out our guide Business Types: How to Choose a Business Structure.Table of Contents:
- LLC and Partnership Definitions
- Main Differences Between LLCs and Partnerships
Before jumping into the differences between LLCs and partnerships, let’s make sure you have a good understanding of what each is and go over the 4 main types of partnerships.
A limited liability company (LLC) is a formal business structure that is recognized as a separate legal entity from its owners, which are known as members. LLCs are a flexible business structure that can have a single owner (known as a single-member LLC) or 2 or more members (multi-member LLC). LLCs combine the features of pass-through taxation that are common to sole proprietorships and partnerships with the limited liability protection that corporations offer.
A partnership is a business structure involving multiple parties who own a company. Partners agree on the share percentages of all stakeholders, which determines the degree of ownership. The total number of shares allocated to the partners must equal 100 percent. A partnership and an LLC are both pass-through entities, although the Internal Revenue Service considers a partnership a taxing entity, which is not the case with an LLC.
4 Types of Partnerships:
- General Partnership: This form of partnership enables multiple individuals to pull resources and form a commercial enterprise. They join the partnership as co-owners of the business with equal rights. The owners share legal obligations and personal liability in matters concerning the venture’s commercial activities. A general partnership is easy to form on the condition that two or more people join forces to run the business. With this business structure, you do not have to worry about filing or ongoing operational requirements like annual meetings.
- Limited Partnership: This option allows you to co-own a business venture with a split into a limited and general partner. This arrangement entails assuming ownership with personal liability on one part as a general partner. On the other hand, you can become a limited partner after investing your resources in the venture. This branch of the partnership does not give you the right to participate in the decision-making process, but you do not assume personal liability for the company’s debts.
- Limited Liability Partnership (LLP): An LLP shares similarities with a general partnership, but co-owners take advantage of limited personal liability. Entrepreneurs usually opt for this business structure when forming a venture that focuses on service businesses, such as legal firms, medical services, and accounting firms. However, co-owners in a limited liability partnership assume liability for the business’ dealings in the event of malpractice.
- Limited Liability Limited Partnerships (LLLP): This form of partnership is a viable option if you are looking to form a commercial venture without assuming personal liability. It extends this benefit to both limited and general partners. A limited liability limited partnership’s operations are identical to an LLP while shielding the partners from any lawsuits resulting from the company’s day-to-day operations. It is important to note that some states do not register LLLPs.
When it comes to LLC vs partnership, you need to consider differences in liability protection, registration requirements, and taxation. The LLC requires an operating document signed by the owners.3 Key Differences of LLCs vs Partnerships:
The process of formation and registration is quite different between LLCs and Partnerships. Since LLCs are a formal business structure, meaning, they are recognized by the state as being separate entities from their owners, they require the filing of official paperwork to be formed. The formation paperwork for an LLC is known as Articles of Organization. To complete the formal filing process you will need to submit the completed Articles of Organization document and a filing fee to your state’s secretary of state office. Once an LLC is formed, you will also need to pay on-going fees to keep your LLC in good standing with your secretary of state office.
General Partnerships, on the other hand, are an informal business structure, meaning that they are not recognized as a separate entity from their owners. As a result, you can form a general partnership without filing any registration documents with the state, as long as you use a name that includes the last names of the business partners. To get started with a general partnership all you will need to do is create a partnerships agreement that outlines the ownership interests of the business and other key information.
With this in mind, it’s important to point out that many general partnerships find the default naming requirements for general partnerships as less than ideal. If you want to operate a general partnership under a name that doesn’t include the owners last names, you’ll need to complete a DBA name filing. In addition to this, both LLCs and partnerships are still responsible for registering for and obtain all required business licenses and permits.
Key Formation and Registration Takeaways:
- Requires Filing Formal Paperwork (Articles of Organization)
- Requires Paying State Filing Fee
- On-going Fees to Maintain LLC Status
- Can choose any available name that conforms with naming rules
- No Formal Paperwork Filing Required
- No Upfront Filing Fee to Start
- No ongoing maintenance fees
- Must File a DBA if business name doesn’t include owners last names
- If you are looking for more information on how filing for a DBA works, check out our guide: How to Get a DBA
- For a more detailed look at the LLC Formation Process, check out How to Start an LLC: A Step-by-Step Guide to Forming an LLC
The most significant difference between a general partnership and LLC is in regards to personal liability protection. As the name implies, LLCs provide limited liability protection for their owners. Personal liability protection is significant because without it the owners of a business can be held personal liable if their business is unable to pay business debts or is sued. Without personal liability protection a business’ owners could end up having personal property like their home, car or personal bank account used to pay off debts or judgements from a lawsuit.
One of the significant drawbacks of a general partnership is that the business’ owners have unlimited personal liability. This means that liabilities have no maximum threshold and if needed, owner’s personal assets can be seized to pay liabilities off. A general partners liability risk extends even to the actions of your partners, meaning that even if you personally haven’t done anything wrong, your personal assets could be at risk because of the actions of your co-owners.
This is the primary reason that many small business owners choose to form an LLC over a partnership. While you can use one of the more specialized forms a partnership can take like a limited liability partnership (LLP), in many states these are not the same level of liability protection as afforded to an LLC. In 21 states, LLPs are offered what is known as a “limited shield”, where limited liability protection is greatly reduced. In the remaining jurisdictions, LLPs liability protections can vary greatly, as outlined in the Journal of Accountancy.
Liability Protection Takeaways
- Owners enjoy limited liability protection
- Personal assets do not cover operational debts
- Owners may become personally liable if they guarantee a loan using personal assets, among other conditions
- Partners face unlimited liability risks
- Personal assets can be seized to cover business debts
- Each co-owner is liable for partners’ unprofessional conduct
If you want to learn more about the benefits an LLC provides, including their limited liability protections check out this guide:
What is an LLC and how does it work?
When comparing LLCs vs partnerships taxation is the next main difference between the two. Both LLCs and partnerships are pass-through taxation entities. This means that the business itself does not pay taxes. Instead of directly paying taxes, both business structures pass the profits or losses through to their owners personal income. After this each owner is responsible for paying all applicable taxes.
While multi-member LLCs are treated the same as a partnership for tax purposes by default they have a significant advantage in flexibility. Unlike a partnership which must adhere to pass-through taxation, LLCs can elect to be treated like a C Corporation or S Corporation for tax purposes. This is done by completing and filing the appropriate form with the IRS.
If an LLC wants to be treated as a C Corporation, where they are subject to corporate taxation but can then retain earnings they file Form 8832 with the IRS. In addition to C Corporation taxation, LLC can also elect S Corporation taxation. S Corporation tax status can be very beneficial to some LLCs as it can greatly reduce employment taxes in the right situation. LLCs that meet the subchapter S tax requirements can obtain S Corporation taxation status by filing form 2553 with the IRS. If you want more detailed information on taxation selection for an LLC, we suggest contacting a CPA, tax accountant or other licensed tax professional for personalized suggestions that fit best for you.