When you start a business with a partner, you have to choose a business structure. Learn about the differences between an LLC and a partnership.
When two people go into business together, the most common business structures to form are a limited liability company (LLC) or a partnership. The partnership is easy to form, but the LLC provides some more advantages when it comes to taxes, management, and potential liabilities.
A partnership is formed when two or more people agree to go into business together. A general partnership doesn’t need to formally register before doing business. However, the partnership doesn’t provide legal protections for the owners’ personal assets.
The main advantage of a general partnership vs LLC is simplicity. The partnership is formed when the partners agree to go into business together. No formal registration is required. The partners can use a partnership agreement to lay out the size of their ownership interest and how they want to share profits.
A partnership uses “pass-through” taxation. At tax time, the partnership files an informational return but doesn’t pay income taxes at the entity level. Instead, each partner pays income tax, self-employment tax, and other taxes on their share of the profits.
The biggest disadvantage of partnerships vs. LLC is that the business doesn’t exist as a legal entity that’s separate from its owners. The owners’ personal assets are at risk if anyone sues the business or the partnership owes a debt. Each partner is responsible for business debts.
Some people wonder, is a partnership an LLC? Unlike a partnership, one or more people can own an LLC. The LLC owners, called members, must form the business following state business laws before operating. The LLC’s operating agreement defines ownership rights. One major difference between an LLC and a partnership is that the LLC exists as a separate entity, which helps protect members’ personal assets.
Personal liability protection is another advantage of registering as an LLC vs partnership. If someone has a claim against the LLC, they must sue the business. Creditors can’t access owners’ personal assets unless the owner commits some personal wrongdoing such as malpractice or negligence.
By default, the IRS taxes LLCs as partnerships. The LLC uses pass-through taxation, and owners pay self-employment and income taxes without the business itself first being taxed. However, unlike partnerships, LLCs can elect to pay taxes as a C corporation or S corporation. For some LLCs, this could lower the company’s tax burden.
If you choose to be taxed as a C corporation (the default form of corporation), you’ll be taxed twice on your profits — once at the entity level and then at the individual level when you file your personal tax returns. Despite this double taxation, certain LLCs may benefit from this tax structure, as it has the most possible deductions.
Being taxed as an S corporation also has pass-through taxation, but it also allows LLC members to earn money from the business both from its profits and by being paid a salary. In some instances, this could reduce the self-employment taxes members pay because they would pay the Social Security/Medicare portion of their taxes on their salary, but not their share of the LLC’s profits.
When considering the difference between a partnership and LLC, the biggest disadvantage is that the LLC has additional costs and maintenance. To form an LLC, you must file Articles of Organization or a similar formation document with your state and pay a one-time fee. In most states, you must also file an annual or biennial report and pay an accompanying fee to keep your business in good standing.
Here’s an overview of the partnership vs LLC pros and cons.
When it comes to choosing between a partnership vs LLC, one of the biggest differences is liability protection. The partnership is easier to form, but the business owners are subject to unlimited liability for business debts. In other words, if the business is sued or goes into debt, the partners could lose all their personal assets, including their savings, home, auto, etc.
There isn’t much difference between LLC vs partnership taxes. For tax purposes, the IRS treats the LLC as a partnership. Both business forms use pass-through taxation, and owners pay income tax from the business’s profits on their personal tax returns. However, the LLC has the flexibility to choose to be taxed as an S corporation or a C corporation, which could provide a tax advantage for some LLCs.
When you run a partnership, the partners are joint owners with the right to operate anything within the business. The partnership agreement delineates each partner’s responsibilities. The LLC is governed by the operating agreement, a document the members agree on that outlines how the LLC will be organized and run. The operating agreement spells out things like much of the company each member owns, how profits are divided, and who has decision-making power. The members can choose to make business decisions together, in which case they’ve formed a member-managed LLC. Or, they can appoint a manager to manage the business. In a manager-managed LLC, the manager handles the LLC’s day-to-day operations.
What are the benefits of an LLC vs a partnership? The type of business structure you choose depends on your state, goals, and business activities. In general, an LLC provides greater liability protection and tax flexibility than a partnership. A partnership involves less paperwork and fewer state fees but provides no liability protection for the owners. Consult a legal professional to learn more about partnership vs LLC so that you can make an informed decision.
Our team of business experts is here to guide you through all phases of business ownership. If you decide an LLC is right for you, let us complete the registration process for you. We can handle the paperwork, so you have more time to focus on your business. Launch your company today for $0 with our LLC Formation Services so you can get your dream business up and running.
Disclaimer: The content on this page is for informational purposes only, and does not constitute legal, tax, or accounting advice. If you have specific questions about any of these topics, seek the counsel of a licensed professional.
A partnership is an agreement between two or more people to share ownership and profits in a business. On the other hand, an LLC is a separate legal business entity that one or more people can form. While partnership owners face liability for business debts, forming an LLC provides the members with limited liability protection.
An LLC can be a partnership for federal income tax purposes because the IRS automatically classifies LLCs and partnerships as “disregarded entities.” LLCs and partnerships use pass-through taxation, and owners report business income on their personal tax returns.
A partnership requires more than one owner. An unregistered business run by a single owner is a sole proprietorship. Like a partnership, a sole proprietorship is not separate from its owner and doesn’t provide personal liability protection. A single owner can form an LLC. In that case, the IRS treats it as a sole proprietorship for federal tax income purposes, but the owner has limited liability protection from the debts of the business.
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