LLC vs Limited Partnership: Everything You Need to Know
In the past, corporations and partnerships were the only options entrepreneurs had for starting a business. Today, there are more business formation options, and most business owners start with a limited partnership (LP) or a limited liability company (LLC).3 min read
Comparing LLC vs. limited partnership is essential when starting a business.
In the past, corporations and partnerships were the only options entrepreneurs had for starting a business. Today, there are more business formation options, and most business owners start with a limited partnership (LP) or a limited liability company (LLC).
LLCs and LPs are two of the most popular business options because they offer:
- Management control
- Pass-through taxation
- Limited liability
For tax purposes, both LLCs and LPs are treated as general partnerships. However, they offer a major advantage of corporate-style limited liability. Some business owners even choose to combine the two structures, forming an LLC as a general partner to mitigate liability problems better.
Most states allow business owners to form limited partnerships and limited liability companies. However, check with your secretary of state to make sure you can form your preferred structure. Which structure you choose largely depends on:
- Your goals
- The type of business
All About Limited Liability Companies
An LLC is a hybrid business structure that mixes characteristics of:
- Sole proprietorships
Each owner, who is referred to as a "member," enjoys limited liability similar to that of a corporate stockholder. With an LLC, owners can be:
- Other LLCs
Many entrepreneurs choose an LLC structure because it offers more flexibility than a corporation. For example, there are no limits on the number of members an LLC may have. LLCs also boast partnership-style tax advantages, such as pass-through taxation.
Perhaps most importantly, LLCs do not pay their own taxes. All profits and losses pass on to members, who then report the finances on their personal income taxes. With pass-through taxation, members are not subjected to double taxation such as with a corporation. They also receive tax relief if the LLC performs poorly.
Unlike a corporation, LLCs do not have to observe certain formalities such as:
- Holding director meetings
- Submitting annual reports
- Satisfying shareholder requirements
Members can also choose how to allocate profits and losses, depending on partnership interests and ownership.
Limited liability companies are recognized in every state, plus the District of Columbia. Every state also permits single-owner LLCs. Some states, however, do tax LLCs like corporations.
Best of all, a business that is currently a sole proprietorship can change its structure to an LLC using "check-the-box" regulations, which doesn't come with any federal tax consequences.
Unlike a basic partnership, LLCs need to register in their state through the secretary of state's office. Compared to a partnership, an LLC can separate business and personal assets and liabilities, although an LLC must report earnings using IRS Form 1065.
All About Limited Partnerships
A limited partnership (LP) is a business with one or more general and limited partners. General partners participate in management activities and are liable for partnership obligations. Limited partners have no liability and do not participate in management activities beyond their investment in the business. However, limited partners do receive profit shares based on their capital contributions.
Most partnerships choose an LP structure because passive investors like the idea of not being liable for the company's debts and other obligations. They also enjoy personal asset protection.
Another benefit to forming an LP is that it's easier to advertise limited partner interests purely as investments, allowing general partners to raise capital without having to hand over management roles to outside investors. LPs also cannot be dissolved if one of the partners:
- Passes away
- Is replaced
- Leaves the company
Unlike corporations, limited partnerships protect each partner's interests from being confiscated when the partner is personally sued. In a corporation, a shareholder's stock can be taken away in a personal lawsuit.
LPs also have similar tax advantages to LLCs, although corporations cannot own them.
LLC and LP Similarities
Limited liability companies and limited partnerships are similar in the following ways:
- Flexibility: Founders are flexible in how they structure the business and define owners' rights and responsibilities.
- Pass-through taxation: The business itself doesn't pay federal income taxes; instead, the members or partners report business income and losses on personal tax returns.
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