For many entrepreneurs, the decision between an LLC and a partnership can be difficult.
The LLC is often seen as more complicated to set up, while the partnership seems to have fewer restrictions on who can enter it.
It's a dilemma many entrepreneurs have when starting their own businesses. The answer to this question varies depending on your business's needs.
For this reason, this blog post will walk through the pros and cons of each structure and help you decide which one is right for you.
What Is the Difference Between a Partnership and an LLC?
Partnerships and LLCs are both forms of limited liability companies.
In general, a limited liability company is a business structure that offers personal protection from lawsuits and claims against your business as provided by corporations but without some of the drawbacks, such as double taxation.
These structures are typically used to lower self-employment taxes while offering limited liability for owners if anything goes wrong or there is a lawsuit.
The limited liability company (LLC) was developed as an alternative to corporations, limited partnerships, and general partnerships.
LLCs combine some of the benefits of these traditional business structures while removing many disadvantages, such as double taxation or unlimited personal liability for owners if they are sued or incur business debts.
On the other hand, partnerships are formed by two or more people who join together to run a business for profit.
Partnerships can be limited liability partnerships (LLPs) in some states but not limited liability companies (LLCs).
An LLP is similar to an LLC because it offers limited personal protection from liabilities incurred by the partnership.
The main difference between these structures is that limited liability companies (LLCs) are separate legal entities.
Types of LLCs
LLCs are business structures that include LLC members. LLCs are limited liability companies, which means the personal assets of LLC members cannot be touched if there is a lawsuit or debt against LLC.
LLC members can also impact how much money they would like to contribute towards running the LLC annually through a yearly form.
Single-Member LLCs
LLCs that only include one member are considered single-member LLCs, which is the owner of the LLC.
An SMLLC can be taxed as a sole proprietorship (a business owned by an individual) or become an S corporation.
An LLC provides its owners, known as members, with liability protection and helps streamline business expenses by allowing for pass-through taxation.
Unlike a corporation with shareholders who are taxed separately from the company itself, an LLC offers the tax benefits of sole proprietorship while also protecting members from personal liability.
Multi-Member LLCs
Multi-member LLCs are LLCs with more than one member and can also be taxed as a partnership or S corporation. LLC members elect how the LLC will be taxed.
Multi-member LLCs with more than one member must have a written operating agreement.
This agreement should address how the LLC will be taxed and what will happen if a member leaves or dies.
The IRS treats any business with multiple owners as a general partnership. If you want your company to be a multi-member LLC, you need to register with the state.
Types of Partnerships
Partnerships are structured as an agreement between two or more people who are conducting a business together.
The partners can be individuals, corporations, limited liability companies (LLCs), limited partnerships (LPs), or any other form of organization that has the right to enter into contracts under state law.
Partnerships have two basic types: a general partnership, a limited liability partnership, and a limited partnership.
Limited Partnerships (LPs)
In a limited partnership, one partner is allowed to manage the company while the other partners can be passive investors only.
A limited partnership has different tax treatment from an LLC as well as double taxation if there's no specific limited partnership provision.
A limited partnership has limited tax treatment that is often more advantageous than an LLC if there are passive investors in addition to a general partner who manages the company.
Read More: LLC vs Limited Partnership
Limited Liability Partnerships (LLPs)
A limited liability partnership (LLP) is a limited liability entity with characteristics similar to those of a general partnership.
In an LLP, partners are shielded against personal liability for the debts or malpractice claims of the partnership.
Each partner must file an IRS Form 1065 Schedule K, which reports his share of the company's income or loss, with the IRS.
A general partner's revenue is taxable and subject to self-employment tax. A limited partner, on the other hand, reports his share individually.
General Partnerships
A general partnership requires all limited partners to contribute money, labor, or skill toward the partnership's business operations and have unlimited liability for company debts.
Individuals generally do not want their personal assets exposed in situations where they get sued.
So limited partnerships, limited liability companies, and limited liability corporations are preferred.
What Are the Benefits of an LLC vs. Partnership?
LLCs and partnerships both offer personal liability protection, but in different ways. In the case of a partnership, when business debts aren't paid, the partners' personal assets can be taken to cover these losses.
The LLC offers personal asset protection from all types of liabilities that may arise without losing control over daily management and operations within your business.
A limited liability company is a business entity that protects personal assets from the liabilities of a company.
In other words, if your LLC gets sued or gets into financial trouble, personal bank accounts and credit cards are off-limits to creditors.
An alternative type of partnership called a limited liability partnership (LLP) offers protection for personal assets while giving limited partners some control over management decisions.
Tax Advantages of LLC vs. Partnership
Pass-through taxation is one of the biggest benefits of an LLC. This means that all revenue and expenses are passed through to personal tax returns instead of being taxed at a corporate level.
By default, an LLP is taxed as if it were a partnership meaning personal income taxes on profits earned by each partner come due every year for state and federal deductions.
However, the LLP can choose to be taxed as a corporation if desired.
The LLC offers personal asset protection from all types of liabilities that may arise without losing control over daily management and operations within your business.
Meanwhile, single-member LLCs are treated as sole proprietorships for tax purposes unless they elect otherwise.
They report their income on Schedule C and pay self-employment taxes.
Partnerships pay taxes on income earned every year, and personal tax returns must be filed for each partner. Co-owners are taxed as limited partners even if they take no active part in the business.
Does an LLC Need a Partnership Agreement?
You should create a written agreement between all members of an LLC to outline the terms and conditions each member is responsible for.
This partnership agreement can include any other details related to the company's operating procedures, such as how disputes will be handled or what happens if a partner leaves.
This partnership agreement (or LLC Operating agreement) does not need to be filed with the state, but it would be helpful to have a written partnership agreement that sets forth the member's rights and responsibilities.
If a partnership agreement exists, it should include each member's ownership interest in the partnership and their percentage of voting rights.
It also needs to stipulate what will happen if one partner withdraws from the partnership or dies during their term as a co-owner.
How Do LLCs and Partnerships Protect Personal Liability?
An LLC can shield owners from personal responsibility for any misconduct committed by the co-owners or workers while conducting business.
If a creditor wins a lawsuit against the LLC on behalf of the owner or employee, creditors may take its money or property to pay off the judgment.
The owners would not, however, be personally responsible for the debt.
A co-owner of the LLC who was involved in the action or wrongdoing might also be held liable for their actions, but a co-owner of the LLC who was not involved in the act or wrongdoings would not be.
In general partnerships, a group of people forms a partnership agreement to manage the company together, with each partner assigned a distinct position.
In the GP structure, each individual partner is personally responsible for all obligations and judgments against the partnership as a whole, regardless of who incurred the debt.
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FAQs
Can Two Llcs Form a Partnership?
Yes, If the LLCs want to keep their identities separate, they may establish a joint agreement or simply form a new LLC in which each existing LLC owns a membership interest. In that situation, the LLC can operate as non-member-managed; you each get to pick one person to be its manager, for a total of two managers.
Having a new operating agreement is pivotal in this case. A three-member management team is one of the best options for this business structure.
Each LLC is assigned a separate manager, selected by all of the company's underlying LLCs, and a third manager, who the two members have mutually approved.
Any decision requiring approval from two of the managers must be signed off on by at least one.
The LLC may avoid being stuck in a deadlock with the use of a tie-breaking manager.
Can a Limited Liability Company Be a Partner in a Partnership?
Yes. There are no restrictions on who can be a general partner in an associate or collaborative LLC; in fact, there are few if any restrictions. Individuals, corporations, and LLCs are all allowed to own the company.
Furthermore, states do not impose limitations on the types of businesses that LLCs may participate in.
As a result, an LLC may act as a general partner in a partnership.
As a partner, you can be held personally liable, and you might elect to run your firm as an LLC and participate in general partnerships as an LLC.
As a result, your LLC is subject to full liability as a general partner, but it nonetheless protects members' personal assets.
How Do You Pay Yourself in a Limited Liability Partnership?
In a business partnership, you may take a percentage of the profits your firm makes as a draw.
You report this figure in Schedule K-1 and pay taxes on your share of the partnership's profits and losses on your personal income tax returns. Most likely, you wouldn't be compensated as an employee would.
A partnership is a pass-through entity, which means it isn't taxed.
Instead, each partner pays a portion of the overall partnership tax on profits. The partnership agreement determines the amount paid to each limited partner.
Do LLPs Need a Registered Agent?
A limited liability partnership must hire a registered agent when forming the partnership agreement.
A law firm can serve as the registered agent for an LLP, or you can hire a third-party agent.
The law firm or the registered agent must have an office in the state of your LLP, and they will be responsible for receiving important legal notices on behalf of your company.
What Kinds of Businesses Are Allowed to Have an LLP?
Organizations use a partnership with multiple owners or groups of professionals, such as lawyers, CPAs, and other licensed professionals.
Certain states don't permit limited liability partnerships, and they may be restricted to specific sorts of vocations such as physicians, attorneys, and bookkeepers. If you're thinking about this sort of business entity, check with your state first.
What Is the Difference Between a General Partner and a Limited Partner?
A limited partnership is a business structure where the general partner manages and runs it, but the limited partners have no say in management.
However, the general partner of a limited partnership has full responsibility for any debt, while each limited partner has liability up to their personal investment amount.
The Key Takeaway: Is It Better to Form an LLC or a Partnership?
Although an LLC requires no general partner, it can be run by its members or a group of managers, and the other members can act as passive investors.
The LLC is governed by its written operating agreement, which specifies such topics as how profits and losses are distributed, each member's capital contributions, how decisions are made, as well as the method for admitting new members, and so on.
Unlike an LLC, an LLP has a partnership agreement rather than an operating agreement as to its governing document.
All partners may participate in company operations, or certain business partners may be "silent partners" who contribute through investments.
However, tax flexibility and liability protection are two key benefits of an LLC over a partnership, which is why LLCs are usually more popular among business owners.
Make sure to read our guide on how to start an LLC if this business structure is what you are looking for.
