LLC vs. a Partnership

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The limited liability company (LLC) is a popular business legal form, and it has many similarities to the partnership legal form. In fact, an LLC pays income tax as a partnership (more details below). But there are some differences between an LLC and a partnership that you should consider before deciding on which is better for your new business. The owners of a partnership are partners, and there may be different types of partners. The owners of an LLC are called members.

Formation of Partnerships and LLCs

The process of forming a partnership and an LLC is similar. Both are formed by registering with the state in which the business wants to operate. Check with your state's business division (usually in the secretary of state department) for information.

  • Forming a partnership. Partnerships are registered with a state, and there can be several different types of partnerships, depending on the profession of the partners and the wishes of the owners for management responsibility and investment. Unlike a corporation, which typically issues stock, the partners share directly in the profits and losses of the business, depending on their percentage share. The ownership share of partners can be any percentage, as long as all the percentages add up to 100%. The partners determine partnership share at the time the business is formed, and this determination is part of the partnership agreement
  • Forming an LLC. Like a partnership, an LLC is formed in a specific state. The business files articles of organization (in some states, a certificate of organization) with the state's secretary of state. Most LLCs function under an operating agreement, which defines member percentages and answers other "what-if" types of questions.

Liability in Partnerships and LLCs

The difference in liability protection is the single biggest difference between partnerships and LLCs. Partners or LLC members can be liable for debts of the business and for lawsuits against the business.

  • Liability in Partnerships. In a general partnership, each partner has personal liability for the debts of the partnership. In addition, each partner has personal liability for the actions of all of the other partners. Some partnerships may include limited partners who have invested in the business but who don't participate in the day-to-day management of the business.
  • Liability in LLCs. In contrast, an LLC is set up specifically to provide liability protection to its members, hence the term "limited liability." If the LLC maintains its separation from the personal affairs of the member, LLC members are only liable for the debts of the business entity to the extent of their personal investment.

There are some circumstances when LLC members can have personal liability:

  • If there is no clear separation between the business and the individuals
  • If one or more members personally guarantee a business loan
  • If a member engages in fraud or illegal activities goes beyond the scope of the duties of a member
  • If one or more members has mismanaged the affairs of the LLC.

Members of an LLC are also liable for specific debts of the LLC if they personally sign to be responsible for those debts. For example, if an LLC purchases a building, and an LLC member signs a personal guarantee for the mortgage, the member is liable for the loan if the LLC can't pay. 

Taxes in Partnerships and LLCs

Partnerships and LLCs are "pass-through" taxing entities. That is, the taxes are passed through to the owners (partners or members) on their personal tax returns.

  • Taxes for Partners. A partnership files a partnership tax return every year on Form 1065, but no tax is due by the partnership. Instead, a Schedule K-1 is given to each partner, showing the amount of the partner's share of the profits or losses for the year. Then, the partner files this Schedule K-1 with his or her personal tax return.
  • Taxes for LLC Members. LLC's are not recognized by the IRS as a taxing entity. So, multiple-member LLCs are taxed in the same way as partnerships, passing through the income or loss to each member's personal tax return using the Schedule K-1. Single-member LLCs are taxed as sole proprietors, filing a Schedule C along with their personal tax returns. LLCs may choose to be taxed as a corporation or an S corporation. Partnerships don't have this tax option.

Profit and Loss Distribution

For both business entities, profits and losses are distributed directly to the owners. Unlike a corporation, there are no stockholders and no stock is offered to owners.

Registration and Record-Keeping

Partnerships and LLCs are both registered with a state and both should have an operating document (partnership agreement or LLC operating agreement).

  • Records for Partnerships. Unlike corporations, partnerships have no specific state requirements for keeping records of partnership activities or minutes of partner meetings.
  • Records for LLCs. LLC's must maintain strict separation from the members' personal affairs, sometimes called a corporate veil. If the separation isn't strictly kept, the LLC members may become personally liable for LLC activities. An LLC has some requirements to keep records and to hold meetings. Check with your attorney to see what the requirements are for your state. LLCs and partnerships formed in a state must make reports to their state periodically. This might be an annual report or biennial report, depending on the state. Typically these reports are due either yearly or every other year.

The Limited Liability Partnership

Some states allow partnerships to form a limited liability partnership. In this type of business entity, partners are not exempt from liability for the debts of the partnership, but they may be exempt from liability for actions of other partners. In an LLP, all partners have the same general management responsibilities. Many professionals form LLP's to protect partners from malpractice claims against other partners.