Key Takeaways

  • An LLC is a separate legal entity that combines elements of both corporations and partnerships but is distinct from both.
  • LLCs offer limited liability protection like corporations but are taxed like partnerships (unless they elect otherwise).
  • Unlike partnerships, LLCs offer more formal protection against personal liability and require formal registration with the state.
  • LLCs have flexible management structures and can be managed by members or designated managers.
  • Taxation of LLCs can be customized, including options to be taxed as an S corp or C corp.
  • LLCs are more appealing to owners seeking liability protection without the rigid corporate formalities.
  • The right entity depends on factors like tax treatment, management style, liability tolerance, and growth plans.

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.

How LLCs Differ from Corporations and Partnerships

Although LLCs share characteristics with both corporations and partnerships, they stand apart as a hybrid entity. Like a corporation, an LLC is legally separate from its owners, who are protected from personal liability for business debts. Unlike corporations, however, LLCs have fewer compliance requirements—they do not need to hold annual meetings or record minutes.

From a partnership perspective, LLCs provide pass-through taxation by default, meaning profits and losses are reported on the members' personal tax returns. However, unlike partnerships, LLCs must be formally registered with the state and comply with state filing requirements. Additionally, LLCs offer more structure for allocating ownership interests and responsibilities, which can be particularly helpful in managing business operations and resolving disputes.

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.

Legal Liability Comparison

In partnerships, general partners are personally liable for business debts and the actions of other partners. This can expose each partner to significant financial risk. In contrast, LLC members enjoy limited liability protection. This means their personal assets are typically shielded from lawsuits and debts incurred by the business, unless they have personally guaranteed a loan or engaged in wrongful conduct.

This difference is especially important for businesses in high-risk industries or those seeking to attract investors who prefer limited liability without the complexity of forming a corporation.

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.

Tax Flexibility of LLCs

One of the major advantages of an LLC is its tax classification flexibility. By default, single-member LLCs are taxed as sole proprietorships, and multi-member LLCs are taxed as partnerships. However, LLCs can choose to be taxed as a C corporation or an S corporation by filing IRS Form 8832 or 2553, respectively.

This flexibility allows business owners to optimize for tax savings depending on their earnings, industry, and reinvestment plans. For example, electing S corporation status may allow LLC members to reduce self-employment taxes by classifying part of their income as distributions rather than wages. These decisions, however, require careful tax planning and may not be suitable for all businesses.

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.

Key Operational Differences Between LLCs and Partnerships

While both LLCs and partnerships involve shared ownership, their operational structures differ significantly. Partnerships typically function with a more informal structure, often relying on a partnership agreement to outline each owner's responsibilities and profit shares. In contrast, LLCs use an operating agreement, which not only governs profit allocation but also lays out formal procedures for management, voting, member withdrawal, and dissolution.

Furthermore, LLCs can be member-managed or manager-managed, allowing for more flexibility in how decisions are made and who handles daily operations. In a partnership, all general partners typically participate equally in decision-making and operations unless otherwise agreed.

Frequently Asked Questions

  1. Is an LLC considered a corporation or a partnership?
    An LLC is a unique legal entity that combines features of both but is legally distinct from either. It is not classified strictly as a corporation or partnership.
  2. Can an LLC be taxed like a corporation?
    Yes. An LLC can elect to be taxed as a C corporation or S corporation by filing the appropriate forms with the IRS.
  3. Are LLC owners personally liable for business debts?
    Typically, no. LLC owners (members) have limited liability protection, meaning their personal assets are protected unless they personally guarantee debts or commit wrongful acts.
  4. What’s the main difference between a partnership and an LLC?
    LLCs offer liability protection and a formal structure, while partnerships are simpler to set up but expose partners to personal liability.
  5. Can an LLC have only one member?
    Yes. Single-member LLCs are common and offer the same liability protection as multi-member LLCs.

If you need help with is an llc a corporation or 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, Menlo Ventures, and Airbnb.