Key Takeaways

  • Yes, an LLC can be a partner in a partnership. This structure is often used for liability protection, tax flexibility, and operational advantages.
  • Members of an LLC are not called partners, but the LLC itself can join a partnership with individuals, corporations, or other LLCs.
  • Advantages of an LLC as a partner include pass-through taxation, limited liability, and simplified management structures.
  • Challenges may include added complexity in formation, tax filing requirements, and potential differences in profit allocation.
  • A well-drafted partnership or operating agreement is essential to define rights, obligations, and profit distribution among all partners.

Can an LLC have partners is one of the most common questions asked when business owners are trying to determine whether a limited liability company is their best choice among business entities. In fact, LLCs evolved out of a desire to provide many of the protections against personal liability offered by corporations, while providing individuals the same flexibility as to how they divide profits and manage the company they have when their business is a partnership.

Two or more business owners just starting out with a business often choose to operate their businesses along the lines of a sole proprietorship. This form of business entity is preferred, because rather than pay sometimes-costly fees to register with a state, the owners can wait to see if the business works out before transferring the business into an LLC. They can structure the business how they want to manage it and distribute profits through a simple agreement. However, they are personally liable for any debts the business incurs, which can be a point of contention in a partnership if it comes down to assigning responsibilities.

Features of an LLC

There are several aspects of an LLC that differentiate it from a partnership:

  • The legal term “business partner” does not apply to two or more owners in an LLC. They are instead referred to as “members,” although the roles and responsibility each individual plays in the company can be exactly the same as if it were a partnership.
  • LLCs are typically required to file Articles of Organization with the state. The process is rather simple in comparison to establishing a corporation.
  • It is highly recommended that LLCs with more than one member put the roles and responsibilities of each member, as well as the process the business will follow upon dissolution, in a formal document called an Operating Agreement. This document is not required by most states, but from a business standpoint it makes sense because it can help members avoid disagreements and conflicts, if problems arise.
  • LLCs can be “member-managed,” where the owners handle and share equal responsibility of the daily operation of the business. This form of management mirrors the traditional concept of a general partnership, with individuals working side by side. Unless specified otherwise in the Articles of Organization, the business is automatically a “member-managed” LLC.
  • LLCs can also be “manager-managed” where the primarily responsibility of running the company falls to one or more members (or even employees hired for this express purpose), while other members receive compensation for financial investment in the LLC. This resembles the features of a limited partnership.
  • LLCs as a business entity are not taxed. Rather, the members are taxed as individuals, just as would be the case in a partnership. This is referred to as “pass through” taxation. This is an advantage that LLCs have over corporations where the company’s income, as well as its distributions received by the owners, are both taxed. This situation is known as “double taxation.”

Can an LLC Join a Partnership?

Although the term “partner” technically applies to individuals in a general or limited partnership, an LLC can indeed be a partner in a partnership. In such cases, the LLC is treated as a single legal entity — just like a corporation — and it may partner with individuals, other LLCs, or corporations. This approach is common in joint ventures, real estate developments, and professional service firms where entities combine resources for a shared purpose.

When an LLC becomes a partner, it does so under a partnership agreement that defines how profits, losses, management decisions, and responsibilities will be shared. The LLC’s members maintain their limited liability, meaning their personal assets are shielded from partnership debts and lawsuits. However, the LLC must still fulfill its obligations under the partnership agreement, including capital contributions and decision-making responsibilities.

Benefits of allowing an LLC as a partner include:

  • Liability protection: The LLC structure shields its owners (members) from personal liability beyond their investment.
  • Tax flexibility: The LLC can choose pass-through taxation or elect to be taxed as a corporation.
  • Business continuity: If a member leaves or the LLC changes ownership, the entity can continue to act as a partner.
  • Credibility and structure: Partnerships that include LLCs may appear more professional and can facilitate larger ventures.

Differences between LLCs and Partnerships

There are areas where LLCs often differ from partnerships. While most states have established rules to govern general and limited partnerships, regardless of whether formal filing of documents is required, these four characteristics are points where LLCS and partnerships stand apart.

  • Formation: While general partnerships can be formed orally, in writing or through conduct as interpreted by a court, and a limited partnership often requires the filing of a certificate of partnership, LLCs are formally required to file Articles of Organization with the state. In the case of partnerships, as with LLCs, the parties should prepare an operating agreement.
  • Management: General partnerships are typically operated democratically, with each partner having an equal voice in matters of management and, even in the case of a limited partnership, one or more of the parties is responsible for running the company. LLCs can be managed entirely by managing-members who are essentially employees of the LLC and have no stake in ownership.
  • Profit Sharing: General partnerships and LLCs are typically similar in the way profits are distributed between owners. In both cases, owners (general partnership) and members (LLCs) receive an equal distribution of profits. However, in the case of a limited partnership and some instances with an LLC, agreements can be made between parties that create terms for profit payment.
  • Legal Liabilities: This is a key consideration between owners when deciding whether to operate as a partnership or an LLC. In partnerships, legal liability falls on the owners’ personal assets. With an LLC, personal assets are protected from legal action.

LLCs tend to be the next logical step as a business entity for two or more partners in a company.

Advantages and Drawbacks of an LLC as a Partner

While there are clear benefits to using an LLC as a partner, businesses should also understand potential challenges.

Advantages:

  • Pass-Through Taxation: Income and losses “pass through” the LLC to its members, avoiding corporate double taxation.
  • Customizable Structure: LLCs offer flexibility in profit-sharing arrangements, which can be negotiated in the partnership agreement.
  • Enhanced Credibility: Forming a partnership with an LLC can improve access to investors, financing, and contractual opportunities.
  • Asset Protection: Members’ personal assets are protected from lawsuits or debts incurred by the partnership.

Drawbacks:

  • Administrative Complexity: Including an LLC in a partnership may require more detailed agreements and additional filings.
  • Tax Complications: Multi-tiered pass-through taxation may complicate tax reporting and distribution calculations.
  • Potential for Disputes: If the partnership agreement is vague, conflicts over control, voting rights, or distributions can arise.
  • State Law Variations: Some states impose additional compliance requirements when LLCs act as partners.

For these reasons, drafting a comprehensive partnership agreement is crucial. It should clearly outline decision-making processes, dispute resolution procedures, and exit strategies. Without this, default state laws will govern, which may not align with the partners’ intentions.

Drafting an Agreement for LLC Partnerships

When forming a partnership that includes an LLC, the partnership agreement is the cornerstone of the relationship. It should address the following key elements:

  • Capital Contributions: Define how much each partner (including the LLC) must invest.
  • Profit and Loss Distribution: Specify how profits and losses will be allocated among all partners.
  • Management Roles: Clarify voting rights, decision-making processes, and daily management responsibilities.
  • Liability and Indemnification: Outline how liability will be managed and how partners will be protected from legal claims.
  • Exit and Dissolution Provisions: Include buyout procedures, dissolution triggers, and steps for winding down the business.

Even though the LLC is treated as a separate legal entity, it acts through its members or managers. Clearly defining their authority and responsibilities in the partnership agreement reduces the risk of misunderstandings and disputes.

Frequently Asked Questions

  1. Can an LLC legally become a partner in a partnership?
    Yes. An LLC can act as a partner with individuals, other LLCs, or corporations, provided the partnership agreement allows it.
  2. Are LLC members personally liable if their LLC is a partner?
    No. LLC members generally enjoy limited liability and are not personally responsible for the partnership’s debts beyond their investment.
  3. Does the partnership agreement need to change if an LLC becomes a partner?
    Yes. The agreement should explicitly name the LLC as a partner and outline its rights, obligations, and capital contributions.
  4. How is taxation handled when an LLC is a partner?
    The partnership itself is a pass-through entity. The LLC’s share of profits and losses passes through to its members, who report them on their individual tax returns.
  5. What risks should I consider before allowing an LLC as a partner?
    Risks include added complexity in agreements, potential tax complications, and the need for detailed governance structures to prevent disputes.

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