The benefits of being a limited company over partnership include flexible taxation and limited liability protections for company owners. Partnerships, on the other hand, are very easy to establish and don't require as many formalities as limited companies.

LLCs and Corporations vs. Partnerships

Before starting a business, you must choose an organizational form for your operations. If you are starting your business with another person, there are several business structures that you can select:

  • Partnership
  • Limited liability partnership (LLP)
  • Limited liability company (LLC)
  • Corporation

Each of these structures has strengths and weaknesses, and choosing the structure that's right for your business generally comes down to three factors:

  • Your business's situation.
  • The laws in your state.
  • How comfortable you are with risk.

Before selecting an organizational form for your business, consult with an attorney to learn more about each form and to decide which best meets the needs of your business. The biggest benefit of forming a partnership is that you will have the freedom to govern your business in whatever way you wish. In fact, you don't actually need any governing structure for your partnership. Partnerships are private entities formed by two or more people. A partnership does not have to report its activities, and the entity itself does not pay taxes.

When your business is a partnership, you and any other owners will be responsible for reporting losses and profits on your personal tax returns and paying the required taxes. This way of taxing partnerships can significantly lower the owners' tax burden. With a corporation, for instance, the government taxes both the entity and its owners, which is known as double taxation. Many people form partnerships so that they'll have better control over their assets. Because partnerships are not considered legally separate entities from their owners, assets can be passed into and out of a business with little difficulty.

If the business is struggling and needs an infusion of cash, one of the owners can use their personal funds and then repay themselves out of the business's earnings at a later time. LLCs and corporations must keep detailed records about the transfer of assets to preserve the protections provided by their organizational form.

Advantages and Disadvantages of LLCs

Tax flexibility is one of the primary benefits of structuring your business as an LLC. The owners of the company are legally separate from the LLC, and in terms of taxes, this means that the IRS does not directly tax the LLC.

Owners of an LLC can choose several different taxation options. For instance, a single-member LLC can be taxed as if it were a sole proprietorship, meaning the profits of the business would be taxed on a single member's tax return. In most cases, LLCs decide to be taxed as corporations. Members of the LLC will typically indicate their desired tax status when writing the company's Operating Agreement.

The IRS will usually treat an LLC as a corporation if the LLC does not select another status. LLCs are also beneficial because they require much less paperwork than S corporations or C corporations. Other than outlining how you will run your business in your Operating Agreement, your LLC only needs to follow the rules in your state for this type of entity. LLCs, because there is no need to follow the strict requirements that apply to corporations, are very easy to maintain.

Finally, structuring your business as an LLC means your members will receive limited liability protection similar to those enjoyed by the owners of a corporation. Essentially, limited liability prevents the members of the LLC from being personally at risk for the company's debts. If the LLC gets into financial trouble, creditors can pursue only the company's assets. The member's personal assets will be shielded. Traditional partnerships do not have access to these protections.

LLCs also come with several disadvantages to consider. For example, unless you elect corporate tax status for your LLC, you will need to pay self-employment taxes. Paying these taxes may mean your tax rate would be much higher than it would with corporate taxation. Members of LLCs can have confusion about their roles. LLCs do not have to have directors or managers, and if the Operating Agreement does not define a member's role, they may not understand what their responsibilities are or how to fulfill them.

If you need help understanding the benefits of being a limited company over partnership, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Stripe, and Twilio.