A limited liability company (LLC) is a popular business legal form, and it has many similarities to the partnership legal form. But there are some differences between an LLC and a partnership that you should consider before deciding on which is better for your business. Keep reading to learn more about the ways LLCs and partnerships are similar and different.
A partnership is an action or process where the group known as business partners all agree to the one business plan and their mutual interests are the same. A partnership is formed by multiple co-owners or partners which together do a business. Partners can have different shares of ownership or have the same shares. And according to their shares, they distribute profits and losses among them. The partnership is not able to have another business entity as an owner or a partner. There are three categories of partnership that is a general partnership (GP), a Limited partnership (LP), Limited liability partnership (LLP). There are nine characteristics of a partnership like sharing of profits, nature of liability, the existence of an agreement, business, agency relationship, membership, a combination of ownership and control, non-transferability of returns, enrollment of the firm.
A single-member LLC is a limited liability company with a single owner, and LLCs refer to owners as members.
Single-member LLCs are disregarded entities. A disregarded entity is ignored by the IRS for tax purposes, and the IRS collects the business's taxes through the owner's personal tax return. Single-member LLCs do not file a separate business tax return.
Single-member LLCs are considered a separate legal entity, because of how liabilities are treated. LLCs protect the owner's personal assets from being seized to pay for business debts.
If an owner wishes to operate a single-member LLC, they need to file paperwork with the state in which they plan to conduct business.
Difference Between LLC vs Partnership
LLC is a limited liability company that can be formed with a minimum of one member. And for partnership, you need to find a partner with a similar vision or goal. And if you don't want a partner or no one is available, then forming an LLC would be the right option. Understanding the difference between an LLC and a partnership can help you choose your business's right structure. If you want to do your own business as a limited liability company may offer you the most versatile tax treatment option. Limited Liability Company was first found in the United States. Most of the states accept it very slowly. A limited liability company is a composed entity formed by the combination of limited liability of corporation and tax advantages of a partnership. But now, it is the most usable entity for businesses.
Key Differences Between LLC vs Partnership
Let us look at the key differences between LLC (limited liability company) vs Partnership as below:
- When two or more people come into the business at the same time with the same goals, they formed a partnership they don't have to do any paperwork. And comparably, in limited liability companies, the business holder must have to record formal articles of organization; it is called a certificate of organization.
- The main key difference between a Limited Liability Company and a partnership is that LLC has a separate legal entity from its owner. A partnership firm doesn't have any discrete or individual legal entity from its partners.
- The liability of partners limited to contribution in the case of a Limited Liability Company, and liability of partners is unlimited in case of a partnership.
- When you want to work on a new company or your partner wants, then understanding the difference between a limited liability company and a partnership can help you choose the proper arrangement for your business.
- The administration structure of a limited liability company is more firm than the partnership.
LLC Vs Partnership: Pros And Cons
Now that we have discussed the differences between an LLC, a partnership (as well as the differences in liability protection), let us now explore the advantages and disadvantages generally associated with each type of business structure.
Benefits Of An LLC
The formation of LLCs has become increasingly popular in the last decade, most likely due to the numerous advantages this particular type of business entity offers to entrepreneurs. Below is a list of the benefits of an LLC:
- Personal Liability Protection: Without a doubt, the single most compelling reason to start an LLC is the business entity's ability to protect the owner's capital. Business owners that file as an LLC are not personally responsible for business debts. As a result, creditors can't go after each owner's personal bank account, house, etc. There are, of course, exceptions to the rule, but they are exactly that: exceptions. For the most part, owners are not usually held liable if the LLC runs out of funds.
- Pass-Through Taxation: LLCs do not actually pay taxes, but their members do. As the name suggests, pass-through taxation witnesses a company's profits and losses transfer directly to subsequent members. Therefore, it is up to the individual members to claim the profits and losses on their personal tax returns.
- No Member Limit: Whereas partnerships limit the number of individuals under a particular business entity, LLCs do not. Likewise, most states don't restrict ownership, which means individuals, corporations, other LLCs, and foreign entities are often permitted to join an LLC as a member. To that end, an LLC doesn't have to consist of multiple members—a single member is entirely possible.
- Compared to their corporate counterparts, LLCs typically coincide with less paperwork and lower filing costs. That said, LLCs still have more paperwork than partnerships.
Although forming an LLC includes many advantages, some downsides should be considered. For starters, as an LLC member, individuals cannot pay themselves wages. Although filing to form an LLC is relatively easy and inexpensive, some states may charge expensive renewal fees, as well as franchise or capital value taxes. Finally, a distinct benefit of LLC vs. partnership (although some may consider it a negative) is that ownership is spread evenly among members.
Benefits Of A Partnership & Limited Partnership
When two or more members would like to form a business agreement, they may opt to form a partnership. Unlike an LLC, partnerships are not required to complete a formal incorporation process through the government. The following are some advantages enjoyed by members in a partnership:
- Pass-Through Taxation For All Members: Partnerships do not actually pay taxes, which means their members do. Again, pass-through taxation will witness a company's profits and losses transfer directly to its members. As a result, the individual partners will need to claim the profits and losses on their personal tax returns.
- No Rigid Corporate Structure Necessary: Partnerships don't follow the same rules as corporations and LLCs, and are subject to much less paperwork and guidelines.
- Members Have the Option To Take On Limited Partnership: Limited partnerships, as their names suggest, subject partners to less liability. There are one or more general partners in a limited partnership and one or more limited partners, which spreads liability across everyone involved.
Arguably, the key difference between a partnership vs. LLC is that members are equally liable for debts and losses made through the business. In this case, creditors can go after each members' personal assets unless the partnership has any limited partners. This also means that each member is liable for the debts and other actions executed by a partner.
Debt and Legal Liability
The difference in liability protection is the single biggest difference between partnerships and LLCs. All LLCs have this protection, but only some types of partnerships do.
Liability in Partnerships
In a general partnership, each partner has personal liability for the debts of the partnership because each partner actively participates in managing the business. In addition, each partner has personal liability for the actions of all of the other partners. General partnerships aren't common for this reason.
Liability in LLCs
In contrast, an LLC is set up specifically to provide liability protection to its members, which is why the term “limited liability” is used in the business name. In most circumstances, LLC members are only liable for the debts of the business entity to the extent of their personal investment.
When LLC Members or Partners Can Have Personal Liability
There are some circumstances when LLC members or partners in a limited partnership or limited liability partnership can have personal liability. These cases are examples of “piercing the corporate veil,” meaning breaking the separation between the individual and the company, and making the company liable for the actions of one or more of the members. These actions include:
- Combining personal and corporate assets
- Excessive control or misconduct (fraud or activities going beyond the scope of the person's duties as a partner or member
- Mismanaging the affairs of the LLC
Members and partners are also liable for specific debts of the business if they personally sign to be responsible for those debts. For example, if an LLC purchases a building, and an LLC member signs a personal guarantee for the mortgage, the member is liable for the loan if the LLC can't pay.
A Single-member LLC has one member, who is also considered the manager. Owners of a Multi-member LLC, however, must decide if they would like the business to be member-managed or manager-managed.
- Member-managed LLC – All of the LLC's members participate in the work of the business. The company must have majority approval of all of its members when entering contracts, securing loans, and making other significant decisions. States will consider an LLC to be member-managed unless its formation documents specify otherwise.
- Manager-managed LLC – Members agree on a manager, either a particular member or members of the LLC or a third-party, to whom they give authority to manage the day-to-day operations and decisions of the business. Any members that are not in a manager role typically make higher-level, strategic decisions, or they might act as passive owners with just a financial investment in the company.
Regardless of whether an LLC is single-member, multi-member and member-managed, or multi-member and manager-managed, it's essential to have an operating agreement in place. An operating agreement, although typically not required by a state, helps ensure all owners are on the same page about how the business should be operated and what are each individuals' roles, responsibilities, and decision-making authority. An LLC operating agreement also spells out what should happen in the event of members leaving (or dying), dissolving the company, or disagreements among members.
Partnerships and LLCs are “pass-through” taxing entities, meaning for both types of businesses, the income taxes are passed through to the owners (partners or members) on their personal tax returns.
Taxes for Partners
A partnership files a partnership tax return every year on Form 1065, but no tax is due by the partnership. Instead, a Schedule K-1 is given to each partner, showing the amount of the partner's share of the profits or losses for the year. Then, the partner files this Schedule K-1 as part of their personal tax return.
Taxes for LLC Members
LLCs are not recognized by the IRS as a taxing entity. Single-member LLCs are taxed in the same way as sole proprietors, filing a Schedule C as part of their with their personal tax returns.
Multiple-member LLCs are taxed in the same way as partnerships, passing through the income or loss to each member's personal tax return using the Schedule K-1. LLCs may file an application with the IRS to be taxed as a corporation or an S corporation. In this case, the LLC is still operated as an LLC, not as a corporation. Partnerships don't have this tax option.
Records for LLCs and Partnerships
Unlike corporations, partnerships have no specific state requirements for keeping records of partnership activities or minutes of partner meetings. An LLC has some requirements to keep records and to hold meetings. Check with your attorney to see what the requirements are for your state.
Both Single-member and Multi-member LLCs have business compliance tasks that they must complete to maintain their business entity and the personal liability protection that it provides. Generally, a Single-member LLC will have less-complex requirements to fulfill than a Multi-member LLC. LLC compliance could include the following tasks and more: paying taxes and fees, submitting an annual report, holding annual meetings and keeping minutes (not a requirement but may strengthen personal liability protection in the event of a lawsuit), renewing licenses and permits, and maintaining company records at the office (e.g., articles of organization, operating agreement, names, and addresses of members and managers, tax returns, bank statements, and financial records). Not all states' requirements are the same. Failure to comply with the rules or meet deadlines could bring on fines or other penalties, lawsuits, or even suspension of the business. CorpNet's free Compliance Portal offers an easy way to keep on top of all compliance to-dos.
Which is best for you?
If you're operating as a single owner, you'll need to choose between a sole proprietorship and a single-member LLC. Each has its perks. If you have basic business operations without any liabilities, a sole proprietorship is likely in your best interest. If you're looking to put more credibility behind your business's name, a limited liability company could be the better choice.