Updated October 27, 2020:

What Is an LLC?

Although a limited liability company (LLC) is not considered either a corporation or a partnership, it shares similarities with each. For example, an LLC is treated as a partnership for income tax purposes and must be formed in a specific state like a partnership. To form an LLC, you must file articles of organization with the secretary of state where your business is located. Owners of an LLC are known as members. Most LLCs have an operating agreement that defines ownership percentages for each member and provides administrative guidance. 

Most new businesses opt to form an LLC since it is considered the ideal business structure for tax purposes. As with partnerships, LLCs are not subject to member meeting requirements and other formalities. An LLC has flexibility in distributing profits and losses to members regardless of their ownership percentages. For example, the operating agreement can indicate that all members receive an equal share of profits no matter what an individual's investment. 

As with corporations, LLC owners are not personally liable for business debts and legal judgments; this provides protection for individual assets. LLCs benefit from a flexible management structure in which any owner can act as a manager.

However, LLCs may face challenges when courting investors since this business entity cannot issue stock. In some states, the LLC may be invalidated if an owner dies or leaves the company. Banks and other specific types of businesses are not eligible for LLC formation.

What Is a Partnership?

A business that has more than one owner is called a partnership. Partnerships must be registered with the state or states where they operate. As with an LLC, the owners are subject to profit and loss sharing. However, in a partnership the amount is dependent on each partner's ownership share. The shares can be of any amount as long as they equal 100 percent. Partnership shares are set when the business is formed and recorded in the partnership agreement

Any two or more individuals working together make up a partnership even if no formal agreement is in place. Partnerships are not required to hold formal meetings. However, having a formal agreement in place to clear up disagreements is recommended. A partnership can be formed with little out of pocket cost. 

Unlike an LLC, in which owners are protected from personal liability, partners may be responsible for business judgments and debts, putting their personal assets at risk. Long, costly legal battles can also ensue if partners disagree on issues that are not officially agreed upon.

Liability for LLCs

The liability difference described above is the biggest distinction between an LLC and a partnership. In certain circumstances, however, LLC owners may be exposed to personal liability. These cases include instances when:

  • No clear distinction exists between the individual and the business
  • A business loan is personally guaranteed by an LLC member
  • A member is found guilty of fraud or other illegal business dealings
  • The LLC's affairs have been mismanaged by one or more members
  • A member has personally signed for a specific debt

Liability for Partnerships

Each member of a partnership is personally responsible for its debts as well as for all the actions of other owners. While profits go directly to partners, one or more partners are responsible for the partnership's litigation and debts.

Taxes for LLCs

Both partnership and LLCs are considered "pass-through" companies for taxation purposes, meaning the company's profits and losses are funneled through to the members' individual tax returns. LLCs are not a legally recognized taxable entity by the IRS.

Single member LLCs must file Schedule C with their individual tax returns since they are considered sole proprietors. Multiple-member LLCs can opt to be treated as a C or S corporation for tax purposes. Few LLCs should opt for C corporation status since it means they will be subject to double taxation.

Taxes for Partnerships

Each partnership is required to file Form 1065 every year by the tax return deadline but does not owe taxes. Each individual partner will be issued a Schedule K-1 that delineates his or her share of profits and losses. This should be filed with the personal tax return.

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