Key Takeaways

  • The difference between a partnership and limited liability company (LLC) includes variations in liability protection, taxation, formality, and ownership flexibility.
  • LLCs provide personal liability protection for owners, while general partnerships do not.
  • LLCs can choose their tax treatment, whereas partnerships are typically pass-through entities by default.
  • Partnerships are easier and less expensive to form but offer fewer formal protections.
  • LLCs can include individuals, corporations, or even other LLCs as owners, while partnerships usually consist of individual partners only.
  • States impose ongoing compliance requirements on LLCs that do not typically apply to partnerships.

Understanding the difference between partnership and LLC is an important step in forming your new business. You'll need to determine which model you would like to adopt as early in your formative phase as possible.

The Difference Between an LLC and a Partnership

A limited liability company, or LLC, is a popular business structure that is similar in some ways to a partnership. The type of structure you choose can have a major impact on how business activities affect your personal financial assets and legal and tax obligations.

Before 1977, partnerships and corporations were the only structures available for businesses to adopt. In 1977, the first LLC law was passed in the state of Wyoming and, by 1996, the business structure was allowed in all 50 states. When deciding which business structure is right for your company, it's important to consider how much liability you are willing to take on for your company in the event of debts or potential legal action.

Formal Structure and Legal Status

An LLC is a formal legal entity that must be registered with the state, offering a separate legal identity from its owners. This separation shields members from personal liability for the company's debts and legal obligations. In contrast, a general partnership is typically an informal arrangement that arises when two or more individuals agree to do business together. Unless registered as a limited liability partnership (LLP) or limited partnership (LP), general partnerships do not enjoy the same liability protections as LLCs.

Registration and Record-Keeping for Partnerships and LLCs

Forming an LLC or a partnership involves similar processes. Both structures require that you register your business in the state in which you intend to operate. A partnership is automatically created when two or more partners decide to operate a business together. This particular structure does not create any form of separation between the owners and the business. An LLC, however, is a separate legal entity. Other differences between the two include:

  • A partnership is not required to file documents, such as articles of incorporation, with the Secretary of State to conduct business.
  • An LLC, on the other hand, is required to file these documents, which are also known as certificates of formation, in the state where the company intends to do business.
  • Partnerships are exempt from paying state fees associated with filing documents like articles of incorporation because such documents are not required for a partnership.
  • While a partnership is not required to file articles of incorporation, it is required to register with the state.

There are multiple possible variations of the partnership business structure. Your specific partnership structure will depend on the type of business the partners intend to operate. If, however, a partnership does not register with the state, no specific requirements exist in terms of record-keeping. The partnership is free to operate in a manner the partners deem most appropriate.

LLCs are subject to certain state requirements, however, and are required to keep a certain degree of separation between owner affairs and business affairs. An LLC is required to adhere to certain requirements in terms of record-keeping and holding meetings. Make sure you check with your attorney, if applicable, to see if there are any specific requirements of this nature in your state.

Ongoing Compliance Requirements

LLCs are generally subject to more extensive state compliance requirements than partnerships. These may include:

  • Filing annual reports
  • Paying state-specific franchise or business taxes
  • Maintaining a registered agent
  • Keeping formal business records and holding annual member meetings in some jurisdictions

Partnerships, especially general partnerships, are subject to fewer state-imposed formalities, making them more flexible and cost-effective for small or informal business arrangements.

Ownership

Limited liability companies can be formed with a single member. However, a partnership is required to have no fewer than two members. An LLC can be comprised of individuals or other business entities such as partnerships, corporation, or even other LLCs. LLCs can also have foreign entities and individuals as owners. Because an LLC is not able to issue stock, it might be difficult to secure investors. This is because investors typically want to see some sort of physical proof of ownership in the company.

Partnerships are not able to have another business entity as an owner or a partner. The partners must be individual people. Part of the partnership agreement that is drawn up when a partnership is formed should include how much share each partner has in the business.

Flexibility in Management Structure

LLCs provide more flexibility in structuring management. They can be member-managed, where all owners participate in day-to-day operations, or manager-managed, where selected managers handle the business affairs. This flexibility accommodates both hands-on and passive investors.

Partnerships are usually governed by the terms outlined in a partnership agreement. All partners typically have equal authority unless otherwise specified. This can lead to challenges in decision-making and management continuity if there is no clear structure or hierarchy.

Liability

One of the most significant differences between an LLC and a partnership involves liability. In a partnership business structure, there is no separation between partners and the company. In simple terms, this means if the partnership faces legal action, the partners are held personally accountable. This level of personal liability could cost partners their personal assets, such as homes, cars, and any other property, if the business does not have adequate assets to cover its debt.

Tax Treatment Differences

Taxation is a critical area of difference between a partnership and limited liability company:

  • Partnerships are treated as pass-through entities by default. Profits and losses pass directly to the partners, who report them on their individual tax returns. Self-employment taxes also apply to each partner’s share.
  • LLCs also enjoy pass-through taxation by default if they are single-member or multi-member entities. However, LLCs can elect to be taxed as an S Corporation or C Corporation by filing IRS Form 8832 or 2553, respectively. This allows greater tax planning flexibility, including potential savings on self-employment taxes.

Frequently Asked Questions

  1. What is the main difference between a partnership and limited liability company?
    The main difference is liability—LLCs protect owners from personal liability, while general partnerships do not.
  2. Can an LLC have just one owner?
    Yes, an LLC can be formed by a single member, unlike a general partnership which requires at least two partners.
  3. Are partnerships or LLCs better for taxes?
    Both are pass-through entities by default, but LLCs offer more flexibility by allowing election of corporate tax treatment.
  4. Which is easier to form, a partnership or an LLC?
    Partnerships are generally easier and cheaper to form, requiring less paperwork and fewer state-mandated formalities.
  5. Do LLCs or partnerships have to follow more regulations?
    LLCs face more state compliance requirements, such as annual filings and maintaining a registered agent.

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