Forming an LLC, corporation or partnership is a big question on the minds of new business owners. It is best to thoroughly understand the mechanics of each structure when deciding how you want to form your business.

History of Corporation, LLC, & Partnership

Up until 1977, the only ways businesses could structure themselves was with a corporation or a partnership. LLC is the newest of all business forms. Wyoming passed the first LLC law in 1977. By 1996, all states were allowed to form LLCs.

LLCs are popular among business forms and they have several similarities to partnerships. As of 2010, the IRS will not recognize the business entity of LLCs. The IRS changed its code in 1988 to make it possible for LLCs to be taxed as a partnership. LLCs can opt to be taxed as a corporation or a partnership.

Differences and Similarities: Formation

Forming a partnership and an LLC have a similar process. They both require registering with the state in which you want to operate. Partnerships are made of two or more partners, or co-owners. There are many different types of partnerships, and choosing one will be best determined by the profession of all the partners and the wants and needs of the owners.

Partners share in all profits and losses of the business based on their percentage of ownership, unlike corporations. Ownership percentages can be anything as long as it equals 100 percent. Partners will decide who has what amount of ownership in the business as it is formed. This is spelled out in the partnership agreement.

LLCs are formed in a certain state, like a partnership. They can be set up by individual people or by companies. The business will need to file the Articles of Organization in its home state with the required state governing office.

LLC owners are referred to as members. LLCs work under an operation agreement. This discusses the percentage ownership of the members as well as dealing with what-if type questions.

Differences and Similarities: Liability

The primary difference in partnerships and LLCs is the personal liability protection. All partners are personally liable for the debts of a partnership. They are also responsible for actions of the other partners.

LLCs are designed to protect their members from liabilities of the business, hence the “limited liability.” As long as LLC members are separate from the business of the LLC, they will only be liable for debts from the business up to their own personal contribution.

There are some instances where LLC members will have some personal liability:

  • When there is no verifiable separation between individuals and the business
  • If a member personally guarantees a business loan
  • When a member is involved in fraud or other illegal actions that are beyond what a member should ever do
  • If a member mismanages the LLC’s affairs

LLC members also will be liable for certain debts of the LLC if they have personally signed for the responsibility of said debts. For instance, if the LLC buys a building and the member signs to personally guarantee the mortgage payment, the member will be held responsible for that loan, should the business be unable to pay it.

Differences and Similarities: Taxes

LLCs are known for their flexibility. If you do nothing, your LLC is taxed in one of two ways by default, depending on how many owners are involved:

  1. Single-member LLCs are a disregarded entity that are taxed like a sole proprietorship. A Schedule C is filed with the owner’s personal income taxes.
  2. Multiple-member LLCs are taxed as a partnership and file an information return on Form 1065 and Schedule K-1s for all members.

By opting to be taxed as a partnership, LLCs are not considered to be separate like corporations; therefore, they will not have their own taxation rates. Profits and losses will go directly to the members and taxed on their personal returns.

LLCs often choose to be taxed like partnerships to avoid double taxation. LLCs and partnerships are considered pass-through with regard to taxes. LLCs with several owners can default to either taxation as a partnership or a corporation.

All domestic LLCs with more than one owner will automatically get partnership status for the purpose of paying taxes. These are LLCs created and operated in the United States. Once you receive your employee identification number, no further action is needed.

If you need help with whether to form an LLC, 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.