LLC vs. Partnership

When deciding between an LLC vs. partnership as your company’s business structure, you’ll have many considerations to address. There are ramifications legally, administratively, and financially when choosing a business entity type. Rushing to a decision can have consequences—BIG consequences—so it’s critical to review your options carefully and seek professional guidance such as from an attorney and accountant or tax advisor.

An LLC (limited liability company) may be owned by just one person (“single-member LLC”) or by multiple owners (“multi-member LLC”). By the nature of its name, a partnership always has multiple owners (“partners”). It is a business that is owned by one or more people. There are several variations of partnerships available.

In this article, we will take a closer look at how the multi-member LLC compares with the following forms of partnerships:

• General Partnership (GP)
• Limited Partnership (LP)
• Limited Liability Partnership (LLP)

We will also break down how the following items are influenced by each entity type:

• Ownership
• Liability
• Formation process
• Ongoing management
• Income tax treatment
• Ongoing business compliance

There is a lot to cover, so let’s get started!

1. Ownership

• LLC Ownership – LLC owners are called “members” There’s flexibility in who can create an LLC. Many states allow individuals (including non-residents of the United States), other LLCs, corporations, and groups to form an LLC. There is no limit to the number of members an LLC may have (although, LLCs electing to be taxed as S Corporation may only have up to 100 members—more on the S Corp to come later in this article!). An LLC may last indefinitely so long as its operating agreement identifies how it shall continue if members leave, die, or other members vote to remove them from the company.
• General Partnership Ownership – A General Partnership is owned by two or more individuals (“partners”). There is no limit to the number of partners a GP may have. While LLCs, corporations, and foreign individuals or entities may form a General Partnership by agreeing to do business in the U.S. with another party, they usually do not enter into this form of business due to the lack of liability protection. There is no legal separation between a General Partnership’s owners and the business. More on this later! A General Partnership may continue to exist when partners leave the business if its partnership agreement allows it. Otherwise, the business may have to be dissolved. To avoid dissolving the company entirely, partners may consider a “buy-sell” agreement allowing remaining partners to buy the ownership rights of the partners that are leaving.
• Limited Partnership Ownership – Depending on the rules of the state where the business will be registered, individuals or other business entities may be eligible to form a Limited Partnership (LP). An LP has at least one “general partner” and one “limited partner.” An LP may have any number of members; there are no limits. General partners typically handle day-to-day operations, while limited partners are silent partners that contribute money or property to fund the company but do not get involved in running the business. You’ll learn more about the roles of general partners versus limited partners later in this article. A partnership agreement is essential to formalize all partners’ responsibilities and document what percentage of profits each partner is entitled to. A Limited Partnership does not need to be dissolved if limited partners retire, pass away, or opt-out of the business. Limited partners may leave the company or be replaced, and the business can continue. If a general partner leaves, states may require that an LP be dissolved unless the business’s partnership agreement states otherwise.
• Limited Liability Partnership Ownership – Essentially, a Limited Liability Partnership is a General Partnership that allows all partners to be involved in managing the business. The major difference is that all partners have the benefit of limited personal liability. This business entity type is popular with professionals such as accountants, attorneys, engineers, and physicians who want to start a company with partners who are licensed in the same trade. Some states (such as California, Oregon, New York, and Nevada) restrict who can form an LLP, and, in some states, the LLP structure isn’t available at all. An LLP may continue to exist if individual partners leave or pass away, provided its partnership agreement sets forth how those circumstances should be dealt with.

2. Liability

• Liability of an LLC – An LLC, because it’s considered a separate legal entity from its owners (“members”), helps protect its members’ personal assets if the business gets sued or cannot pay its financial debts. Members’ personal liability for the business’ legal and financial troubles is limited to their individual investments in the LLC.
• Liability of a General Partnership – In a General Partnership, which is the most basic form of partnership, the business and its owners are considered the same legal entity. So if the business runs into legal or money troubles, the owners’ personal assets are at risk of being taken as reparations to settle those obligations.
• Liability of a Limited Partnership – An LP’s general partners accept full personal liability for the legal and financial debts of the business. Limited partners, as passive owners, have personal liability limited to their investment in the company.
• Liability of a Limited Liability Partnership – An LLP is a legal entity separate from its owners, and states have their own rules about how much liability protection LLP partners receive. Generally, each partner receives liability protection from the negligence or malpractice of the other partners. Partners may also be protected from other debts and obligations of the business. Each partner is responsible for their own negligence or malpractice (and possibly the wrongdoing of people who work for them).

3. Business Formation

Here’s an overview of what’s involved in forming an LLC and the various forms of partnerships. Businesses may have other requirements to fulfill depending on the type of industry, location, and state-specific rules for their entity type.

• LLC Formation – States require that owners file Articles of Organization to register an LLC formally. Some states (such as CA, CT, GA, LA, MO, NM) also require something called an Initial Report (sometimes called a Statement of Information) to track vital information about the LLC. A multi-member LLC must also obtain an EIN (Employee Identification Number).
• General Partnership Formation – Many states do not require any entity registration paperwork to be filed to form a General Partnership. Rather the partnership is considered to be in effect when two or more people enter into business together to make a profit—even if there is no written plan or agreement in place. A General Partnership must obtain an EIN from the IRS for tax reporting purposes.
• Limited Partnership Formation – To form a Limited Partnership, entrepreneurs must file a Certificate of Limited Partnership with the state and pay the required registration fees. An LP must obtain an EIN from the IRS for tax reporting purposes.
• Limited Liability Partnership Formation – Creating an LLP involves filing registration paperwork (Certificate of Limited Liability Partnership) with the state government and paying the required fees. An LLP must also obtain an EIN for tax reporting purposes. As I mentioned earlier, not all states recognize this business entity type. And some states only allow certain types of professionals to create an LLP. Entrepreneurs who want to expand into multiple states will want to consider this potential limitation. If partners form an LLP in one state and then want to operate in a state that doesn’t offer the LLP option, the company might be treated as a General Partnership in the new state (which doesn’t provide the advantage of limited liability). Or they will have to start from square one to form an entirely new legal entity in the new state—leading to more paperwork, more fees, and additional ongoing compliance requirements.

4. Management

• LLC Management – An LLC may choose to be either member-managed or manager-managed. In a member-managed LLC, the owners share the management duties among themselves. In a manager-managed LLC, the members appoint a manager (which could be one or more of the members or other individuals) to handle day-to-day operations and administrative concerns. Members then typically take a passive role, handling higher-level decisions and strategy. An LLC should have an operating agreement that defines members’ and managers’ roles, rights, authority, distribution of profits and losses, and responsibilities. States don’t often request operating agreements to be filed formally. However, they may require that LLCs maintain their operating agreement at their principal place of business at all times.
• General Partnership Management – Often, in a General Partnership, owners share much of the management duties equally. Most legal experts advise that owners in a partnership have a written partnership agreement to define the partners’ roles, rights, authority, the share of ownership, and responsibilities in operating the business. Having a written legal agreement can help ensure all partners are on the same page and avoid disputes about how the business will be run, how profits or losses are distributed, who has the authority to make decisions, and other important points.
• Limited Partnership Management – General partners in an LP are the individuals who manage the business and make most of the decisions. Limited partners do not usually have a say in how the business is run because they are passive investors and must refrain from getting too involved, which could result in them losing their personal liability protection. Some states grant exceptions that give limited partners the right to vote on issues that affect certain aspects of the business. For example, limited partners might be able to vote on adding or removing general partners, changing the partnership agreement, and other strategic decisions.
• Limited Liability Partnership Management – Partners have a good deal of flexibility in what roles they will have in managing an LLP. For example, they might assign responsibilities based on each partner’s areas of expertise and professional strengths or based on each partner’s financial investment in the business. A partnership agreement is key for ensuring all partners concur on how the LLP should be managed, what percentage of ownership each partner has, the conditions for allowing new partners in and existing partners out of the business, and other important considerations.

5. Income Tax Treatment

Tax Treatment for the LLC and General Partnership

LLCs and General Partnerships are “pass-through” entities for tax purposes. Profits and losses of the business flow through to the business owner’s personal tax returns—the business itself does not pay income tax. All business profits are subject to self-employment taxes (Medicare and Social Security) and income tax. In an LLC or General Partnership, owners are not on the company payroll and don’t receive paychecks. Therefore no portion of those taxes is deducted from the owners’ compensation (paid through draws) from the business.

A partnership must file an annual information return (Schedule K-1, IRS Form 1065) with the IRS to report the income, deductions, gains, losses, etc., from its operations. Then the individual partners use information from that form to report their share of the partnership’s income or loss on their individual tax returns.

By default, a multi-member LLC is taxed like a partnership. Therefore, the LLC must file IRS Form 1065. Then, each member uses information from that form to report their share of the LLC’s profit and loss on their personal income tax returns. Some states also require an LLC to pay an annual Franchise Tax.

The LLC entity type provides some tax treatment flexibility that a General Partnership does not.

An LLC may elect to be taxed as a Subchapter S Corporation by filing Form 2553 if it meets the IRS’s eligibility requirements. The potential advantage of S Corp election is that, while an S Corp is still a pass-through entity with all of the business profits and losses flowing through to the owners, only wages and salaries paid to LLC members (who must be set up as employees if they work in the business) are subject to self-employment taxes. Any remaining profits paid as distributions to LLC members don’t get hit with Social Security and Medicare taxes. Note that not all states treat S Corps the same for tax purposes; some honor the IRS election automatically, some require additional filings at the state level, and some disregard S Corp status entirely.

Tax Treatment for the Limited Partnership

An LP’s profits and losses pass through to its partners, who report them on their personal tax returns and get taxed on their share of the profits. Because general partners work in the business, they must pay self-employment taxes on their income from the LP. Limited partners typically do not pay self-employment taxes on their share of the profits because it’s not considered “earned income.” As does a General Partnership, a Limited Partnership must prepare IRS Form 1065, which discloses the business’s profits and losses and how they are split among the LP’s partners. In the event of a loss, usually, only general partners are allowed to report the loss. Limited partners, because they don’t actively get involved in running the business, typically may not report the business loss on their individual tax returns.

Note that in some states, LPs must also pay an annual Franchise Tax.

Tax Treatment for the Limited Liability Partnership

For tax purposes, an LLP is considered a disregarded entity, so its profits and losses are allocated among the company’s partners. The partnership agreement will identify if that allocation will be according to each partner’s share of ownership or a different percentage.

Partners report their portion of the company’s earnings on their personal income tax returns and pay income tax ( to the IRS’s individual tax rates) and self-employment taxes. The LLP entity does have to file an information return (IRS Form 1065) to report income, gains, losses, deductions, credits, etc. In some states, an LLC might also have to pay a Franchise Tax.

6. Ongoing Business Compliance

Compared to a corporation, LLCs, General Partnerships, Limited Partnerships, Limited Liability Partnerships, and Limited Liability Limited Partnerships have fewer business compliance formalities to tend to. However, there are recurring items for entity, industry, or general business related that these business structures may have to address annually or on some other schedule set by the federal, state, or local government agencies that preside over them. Staying compliant is critical for staying in good standing with the state. If a business fails to complete filings or pay fees on time, it risks losing the authority to operate. In the case of the LLC, LP, and LLP, business owners may lose the liability protection provided by those entity types.

Below, I’ve listed several of the possible ongoing compliance responsibilities for each entity type and its owners. These are not all-inclusive lists; depending on where a business is located and the types of activities it conducts, there may be fewer or more requirements:

Ongoing Compliance for the LLC

• File an annual report with the state.
• Hold an annual member meeting and record minutes.
• Assign and maintain a registered agent in the state.
• Report and pay income and self-employment taxes.
• Register for a sales tax ID (seller’s permit).
• Register for payroll taxes (if the business will have employees).
• Pay franchise tax.
• Obtain required business licenses and permits and keep them up to date.
• Keep business’s and partners’ personal finances separate.

Ongoing Compliance for a General Partnership

• Report and pay income and self-employment taxes.
• Register for a sales tax ID (seller’s permit).
• Register for payroll taxes (if the business will have employees).
• Obtain required business licenses and permits and keep them up to date.

Ongoing Compliance for a Limited Partnership

• File an annual report with the state
• Assign and maintain a registered agent in the state
• Report and pay income and self-employment taxes.
• Register for a sales tax ID (seller’s permit).
• Register for payroll taxes (if the business will have employees).
• Pay franchise tax.
• Obtain required business licenses and permits and keep them up to date.
• Keep business’s and partners’ personal finances separate.

Ongoing Compliance for a Limited Liability Partnership

• File an annual report with the state.
• Assign and maintain a registered agent in the state.
• Report and pay income and self-employment taxes.
• Register for a sales tax ID (seller’s permit).
• Register for payroll taxes (if the business will have employees).
• Pay franchise tax.
• Obtain required business licenses and permits and keep them up to date.
• Keep business’s and partners’ personal finances separate.

Read More About Payroll: What is Payroll?

7. The Pros and Cons of Each Entity

To further compare the LLC and partnership business structure, I encourage you to learn more about each at the links below:

• Limited Liability Company
• General Partnership
• Limited Partnership
• Limited Liability Partnership

Below I’ve listed some characteristics that might make business owners gravitate toward the various business entity types.

Pros and Cons of an LLC

An LLC might be attractive to entrepreneurs who want:

• All members have personal liability protection in proportion to their financial investment in the company.
• To expand into other states eventually.
• Ownership flexibility.
• Flexibility in how they manage their business.
• Pass-through taxation (rather than be subject to the “double taxation” that affects C Corporations).
• The option of electing S Corporation tax treatment to lower their self-employment tax burden.

Pros and Cons of a General Partnership

A General Partnership might be attractive to entrepreneurs who want:

• Simplicity; and would rather not formally register their company or have a lot of ongoing compliance responsibilities.
• To run a business in which all partners are actively involved in management duties and day-to-day operations.
• Pass-through taxation (rather than be subject to the “double taxation” that affects C Corporations).

Pros and Cons of a Limited Partnership

A Limited Partnership might be attractive to entrepreneurs who want:

• One or more partners to play a passive role, contributing funds to the company but otherwise being hands-off.
• Pass-through taxation (rather than be subject to the “double taxation” that affects C Corporations).
• A structure that’s attractive to potential investors—limited partners only risk their initial financial investment, so individuals or other businesses may be more inclined to fund an LP than invest in an LLC or other partnership entities.

Pros and Cons of a Limited Liability Partnership

A Limited Liability Partnership might be attractive to entrepreneurs who want:

• To form a business with other licensed professionals in their field.
• To maintain their own client base while pooling resources (such as office space, equipment, employees, and other needs) than taking on those expenses individually.
• All partners have a voice in the management and operations of the company.
• Change ownership percentages without needing to comply with securities laws, which are usually not applicable to LLPs because all partners are considered general partners.
• Pass-through taxation (rather than be subject to the “double taxation” that affects C Corporations).

Get Your Business Filings Right With CorpNet’s Help

The business structure you choose is one of the most critical decisions you’ll face as an entrepreneur. After you’ve gotten professional legal and tax advice and have decided on the most beneficial entity type for your situation, contact CorpNet.

Our experienced team can handle all of your business registration and compliance filings (including formation documents, payroll tax registration, registered agent services, and more) no matter where you are in the United States. Get down to business and get peace of mind—with CorpNet’s help!