If your business has two or more owners, you can structure it as a limited liability company (LLC) or a partnership. The two options have similarities but also a number of differences in the way they're run, the way they're taxed, and the type of liability protection that owners receive.
Here's a look at LLC and partnership features, advantages, and disadvantages.
LLC vs. partnership: Liability for business debts
If you start a business with other people, you automatically have a general partnership. A general partnership is simple to set up and maintain, but you and your partners are each fully liable if the business is sued or can't pay its debts. For this reason alone, many business lawyers discourage general partnerships.
As an alternative, you can set up a formal business entity such as an LLC, limited partnership, or limited liability partnership. In each of these business types, at least some of the owners have limited personal liability. Business creditors can go after company assets, but the owners' personal homes, bank accounts, and other assets are safe.
- LLC. An LLC is not a partnership, though many LLC owners casually refer to their co-owners as “business partners." All LLC owners—known formally as “members"—are protected from personal liability for business debts.
- Limited liability partnership. Most states allow limited liability partnerships. Different states have different rules for such partnerships. Most allow limited liability for some or all of the partners, but some states hold partners liable for business debts or require at least one partner to be fully liable. And some states limit LLPs to certain professions.
- Limited partnership. A limited partnership has at least one general partner and at least one limited partner. The general partners run the company and remain fully liable for business debts. The limited partners are passive investors who cannot be involved in decision-making and aren't liable for company debts. Limited partnerships are mainly used in commercial real estate and other industries that need to raise money from a group of passive investors.
Some states have other partnership options, such as limited liability limited partnerships and professional LLCs. In general, LLCs offer the most liability protection, but certain professions may not be allowed to form LLCs in your state.
What is the difference between LLC and LLC partnership taxes?
An LLC can be a partnership for tax purposes, because the IRS automatically classifies both LLCs and partnerships as “disregarded entities." This means that owners report their share of company profits and losses on their personal tax returns.
However, an LLC does have advantages over a partnership in that an LLC can also elect to be taxed as a corporation. Some LLC owners find that they can save money on taxes and boost their retirement savings by electing S corporation status. However, not all LLCs qualify to be taxed as S corporations.
Taxation is a complex and ever-changing topic. Consult an accountant to see whether you could see a tax benefit by organizing your business as an LLC as opposed to a partnership.
Organizing and running LLCs vs. partnerships
Both LLCs and partnerships are created by filing forms with the state. But there are some differences in the way the two business types are run.
An LLC doesn't require a general partner. Instead, it can be managed by its members or by a group of managers, with the other members acting as passive investors. The LLC operates according to its operating agreement, a document that includes such things as how profits and losses are distributed, capital contributions of each member, how decisions are made, and the procedure for adding new members or dealing with departing ones.
An LLP operates similarly to an LLC, except that the governing document is a partnership agreement rather than an operating agreement. All partners can participate in running the company, or some partners can be “silent partners" who are simply investors.
In general, an LLC offers better liability protection and more tax flexibility than a partnership. But the type of business you're in, the management structure, and your state's laws may tip the scales toward partnership. A lawyer can help you sort through your LLC partnership options and choose the business type that's best for you.