When you start your own business, the type of business entity you create can have a big impact on the work you do in the future. Selecting the right one can improve how your business functions, as well as how you and your co-owner work together. For many entrepreneurs, the final choice depends on weighing the pros and cons of a partnership vs. LLC structure.
Your business structure should never be overlooked. While starting a partnership and starting a limited liability company (LLC) are both fairly simple processes, your decision will have a long-term impact on your tax payments, legal responsibility, and more. Switching between business entities isn’t easy either, so it’s important to make your first choice the right one.
This article will teach you everything you need to know about general partnerships and LLCs, so you can decide which one will be best for your company in the long run.
What Is a General Partnership?
A general partnership is the equivalent of a sole proprietorship for companies with multiple business owners. Whereas a sole proprietorship is the default entity type for a single freelancer or independent contractor, this is typically the default legal entity when two or more people decide to set up a business together. Essentially, the owners are the business.
Many co-owners in a partnership will choose to write up a partnership agreement in case of leadership changes or soured relationships. However, there is no legal need to create or submit any business formation papers to the Internal Revenue Service (IRS). Most states do not require you to submit anything either.
In short, a partnership is the fastest way to start a new business — though a quick start may not always be the best start. We’ll dive deeper into the pros and cons of partnerships further down in this article.
What Is a Limited Liability Company?
Unlike a general partnership, a limited liability company can be owned by any number of LLC owners, known as members. Few states put restrictions on the number of members you can have, so both single-member LLCs and multi-member LLCs are common in the business community.
One of the most important things to remember about LLCs is the fact that your business becomes a separate entity from you, the owners, once it’s set up. This means that you are not your business, so your personal assets and loans will never be muddled with your company’s. This is the main way that you can distinguish LLCs from partnerships, and may be the reason you decide to form a limited liability company as you continue reading.
While LLCs will pretty much always be more complex than partnerships, they are still one of the simplest business structures out there.
Partnership vs. LLC: The Pros and Cons of Each Structure
Now that you’ve had a simple introduction to both partnerships and LLCs, we’ll break down how these two business entities compare across three areas.
As you read on, make sure to think about what business structure benefits are most important to you and your co-owner(s), and what downsides are forgivable. There is no one right answer, so it’s important for you to come to a final agreement together.
Formation of a Partnership vs. LLC
As you may have gathered from our descriptions of each type of business entity, partnerships tend to be less formal than LLCs. Because of this, business formation is usually a piece of cake — all you need to do is decide to earn money with at least one other person.
Even in situations where your state has additional requirements, you’ll rarely be asked to do more than:
- Submit a statement of partnership
- Obtain required business licenses
- Get employer identification numbers
These general partnership requirements will usually have little to no difference from your local sole proprietorship requirements, which means it’s by far the easiest way to form a business with multiple owners.
On the other hand, forming an LLC does require a significant number of extra steps. For example, your state laws will likely require you to:
- Select a unique name for your business
- File Articles of Organization and other locally required business forms
- Pay filing fees that can cost anywhere from $100 to $800
- Select a registered agent
- Obtain required business licenses
- Submit your Statement of Information
Many LLC owners additionally choose to create an LLC operating agreement to formalize how their business runs. In the long run, LLCs continue to require more paperwork than general partnerships.
Taxes for a Partnership vs. LLC
Both general partnerships and limited liability companies have the benefit of pass-through taxation. This means that your business does not have to pay any taxes, and you and your co-owners are only taxed once via your personal tax return. This is quite different from more complex business entities like C-corporations, whose owners pay both personal income tax and business income tax.
However, members of an LLC have a significant amount of flexibility on how they’re taxed. They can file taxes as a:
- Sole proprietorship: If you’re the owner of a single-owner LLC, you can simply file Schedule C with Form 1040 and be taxed as an individual.
- Partnership: Multi-owner LLCs can choose to be taxed like general partnerships. In this case, the members of the LLC must file a Form 1065 partnership tax return. Then, each LLC member files a Schedule K-1 with their personal tax returns, which determines how much you pay within your personal taxes.
- S-corporation: This is similar to filing as a general partnership, but instead of filing Form 1065, an S-corporation files Form 1120S. Then each LLC member files the correct Schedule K-1 with their personal tax returns.
- C-corporation: Though rare, LLCs can pay taxes as a standard corporation. Again, this is not ideal because you will end up being double taxed.
On the other hand, partners are always taxed based on the general partnership tax process that we described above.
Both partners and LLC members must pay self-employment taxes on their shares of the company’s earnings. This 15.3% self-employment tax covers your Social Security and Medicare payments and is required in addition to your income tax.
Liability for a Partnership vs. LLC
Liability protection is one of the most common reasons why business owners choose to put in the effort to form an LLC instead of sticking with a general partnership.
An LLC is a separate entity from its owners, as we noted earlier. This means that you are protected from personal liability in lawsuits, and your personal assets and credit score are protected if you have business debt. Unless you personally guarantee a loan or are solely responsible for mishandling money, it’s unlikely that you as an individual will be held responsible for any issues that arise within your LLC.
On the other hand, owners of a general partnership personally hold all the legal liability for lawsuits and debts happening in their business. This is because the owners are not distinguished from the company.
Another important factor of partnership liability is that a single partner has the power to enter the entire partnership into a legally binding contract. This means that there must be a considerable amount of trust when creating a general partnership, and you must outline guidelines for conflict resolution when you create a partnership agreement.
Frequently Asked Questions
Choosing between an LLC and a partnership business structure is much easier when it’s broken down into pieces. To help you further dissect your options, here are our answers to some frequently asked questions:
1. How do limited liability partnerships compare to general partnerships and LLCs?
Forming an LLP allows partners to tack on the benefit of some protection from legal liability. While its owners aren’t completely separate from the business, limited liability partnerships allow each partner to be protected from the wrongdoings of other partners.
However, LLPs are really only suited for small businesses, as they aren’t as scalable as LLCs. Because LLPs and LLCs require a similar amount of paperwork and filing fees, most business owners choose to take the route of creating an LLC instead, since they’ll receive more flexibility.
2. Do business owners need to have equal shares of a company when forming a partnership?
No, business owners do not need to have equal shares in a partnership, as long as they have 100% ownership of a company when their shares are added together, meaning that shares can’t be sold off to non-owners. However, a simple verbal agreement isn’t enough to make share percentages legally binding. Most partners include details about ownership levels in their partnership agreement.
3. How do I figure out my local requirements for forming an LLC or partnership?
Your Secretary of State is usually your best resource for all the legal requirements behind your business formation. Most Secretary of State websites will provide all the paperwork you need to print and fill out, along with instructions for how to submit your completed paperwork.
Make Your Best Business Decision
Settling the partnership vs LLC debate with your co-owner requires you use an informed decision-making process and weigh the pros and cons of each business structure. Whether you’re looking to invest as little as possible or you’re seeking to separate yourself from your business, one of these entities is likely to be a perfect fit for your business.
Once your business is fully formed, read our guide to how to get a business license, which may be required in your location or in your industry.