This LLC partnership article refers to two types of business entities: a limited liability company (LLC) and a partnership. 12 min read
Updated November 9, 2020:
What is an LLC Partnership?
This LLC partnership article refers to two types of business entities: a limited liability company (LLC) and a partnership. While they are similar legal forms, they differ by way of personal liability, management controls, formal processes, and other characteristics.
Partnership vs. LLC – Differences and Similarities
An LLC, which is also known as a limited liability company, is a popular type of business to enact, and it has similar features to another legal structure called a partnership. They are similar in how they are formed and the “pass-through” taxation method but differ by features such as participant liability.
Formation of Partnerships and LLCs
Forming each kind of structure involves similar steps, including registering with the state where the business does the operation. An LLC, however, often requires more documentation to form it than a partnership, as well as following statutory guidelines.
What Is a Partnership?
A partnership is a kind of business with many partners, who are essentially co-owners. To form a partnership:
- You must have two or more parties who agree to own the business and operate it for-profit.
- The partners share in management activities equally and share the business’ financial gains and losses.
- The amount of profit or loss depends on the amount originally invested by the particular owner.
- Several kinds of partnerships exist, varying according to the industry and owners’ desires.
What Is an LLC?
Forming an LLC involves registering with the state where the business is located, as with a partnership. The majority of limited liability companies operate based on an Operating Agreement, which dictates percentages per member and answers questions as to “what if?” An LLC has the pass-through taxation style of a partnership or sole proprietorship yet has the benefit of personal limited liability like a corporation.
Personal limited liability means:
- LLC owners have a divide between their personal assets and any judgments against the business.
- If the business receives a lawsuit or has a debt, only the organization is at risk; the owners’ personal property, such as a vehicle or home, cannot be touched by creditors.
- Illegal, unethical, or reckless actions by the owners result in the removal of limited liability protection.
Given these distinguishing characteristics, many people consider the LLC format to be an ideal mix of a partnership with a corporation. It is a hybrid structure of partnerships, corporations, and sole proprietorships.
Liability for Partnerships and LLCs
Partners within a partnership have personal liability for the debts incurred in the business and carry personal liability for the activities of the other partners. However, a limited liability company divides the personal assets of the member from any business lawsuit or debt, so that the individual members are not personally held to them. The LLC format provides for personal liability protection for each owner.
There are exceptions to that division between personal and business liability in an LLC though, when:
- At least one member assurances a business loan
- The division between business and individuals is vague
- An owner acts fraudulently or illegally
- At least one member mishandles business matters
- Individual members sign for responsibility for specific debts
Taxes for Partnerships and LLCs
Both structures use “pass-through” taxation, meaning that taxes pass through to the members or partners to declare on their individual tax returns. While a partnership files a partnership tax form annually on Form 1065. Also, a Schedule K-1 is made for each of the partners that show their individual amount of profits or losses over that particular year.
Meanwhile, LLCs are not a tax entity in the eyes of the Internal Revenue Service. Limited liability companies with more than one owner are:
- Taxed in the same way as partnerships, with the above-mentioned pass-through method for gains and losses tallied on each member’s tax form
- Differ than single-owner LLCs
- They are taxed as sole proprietorships
- Must file a Schedule C in addition to a personal tax return
- An LLC (single- or multiple-member) can choose to be taxed as a corporation or S corporation instead
Profit and Loss Distribution for Partnerships and LLCs
The disbursement of profits and losses for limited liability companies and partnerships is different than a corporation as there are no shares and no stock is given to members.
Registration and Record-Keeping for Partnerships and LLCs
- Partnership and LLC reporting guidelines are less specific than corporations
- There are no requirements to keep records or meeting minutes if a partnership isn’t state registered
- LLCs must follow some state rules for record-keeping and have meetings, as well as keep separation from members’ personal activities
- If state-formed, a partnership or LLC must make periodic reports to the state
- Whether reports are annual or bi-annual depends on the state
The Limited Liability Partnership: A Special Case
A specific type of partnership is a limited liability partnership, which is also known as an LLP. It involves partners being immune from liability for the actions of their partners. They are still liable for any debts formed within the partnership entity though.
The members of an LLP have the same management guidelines. A major benefit of forming a limited liability partnership is that a partner is not held liable for malpractice claims made against another partner in the same organization.
Limited Liability Company (LLC) FAQ
Below are answers to popular questions about the formation and operation of a limited liability company.
Do I Need to Know About Securities Laws to Set Up an LLC?
- Provided that you are a sole owner and have no plan to accept investments from outside parties, your ownership of the LLC is not seen as a security
- Thus, you don’t need to know this type of law
- If you have co-owners, the amount of required knowledge of securities law is less clear
- The ownership interests are not viewed as securities if all owners play a role in LLC management (as is usually the case)
- But if there is at least one member who is not an active business manager, such as a friend who invests but does not run any activity in the LLC, then LLC ownership interests are seen as securities by both the state and the federal SEC (Securities and Exchange Commission)
How Many People Do I Need to Form an LLC?
A limited liability company can have just one owner. It only takes one person.
Who Should Form an LLC?
Creating an LLC is favorable if:
- You want your personal assets to be separate from lawsuits and debts within the organization.
- You desire personal protection against possible slip-and-fall lawsuits or other possible claims against your company.
- Common organizations that form limited liability companies are in the banking, insurance, and trust industries.
- Not every type of business can be an LLC
- Certain U.S. states do not allow specific professions to create LLCs. For example, California prohibits accountants, doctors, licensed healthcare specialists, and professionals from forming LLCs
How Do I Form an LLC?
For most states:
- File Articles of Organization in your state
- Apply to the state LLC filing office, usually within the Secretary of State’s jurisdiction
- Pay the appropriate filing fee
- Some states call it a Certificate of Organization or Certificate of Formation
- It’s a straightforward process; the form is usually a fill-in-the-blank format
- Get the form by mail or download it online via your state’s main website (search for Secretary of State or corporations section)
Certain states also require:
- Publish your intention to create a limited liability company in your local newspaper
- Do so before filing Articles of Organization, not afterward
Also, while it is not a legal requirement in most states, you might decide to write up an Operating Agreement that states the guidelines and rights of the owners of your LLC. This agreement makes it clear what responsibilities each owner is held to and dictates how your company will run. Always follow the LLC laws of the particular state where you are doing business for how to run your organization.
Do I Need a Lawyer to Form an LLC?
The process does not require an attorney as every state enables company owners to create their own LLC simply by providing Articles of Organization. For the Articles of Organization, in almost every state, you must submit:
- Your LLC name
- Where the main office is located
- LLC owner names
- LLC owner addresses
- LLC name and address of its registered agent
- A registered agent is an individual or business that volunteers to accept any legal papers for the LLC
Does My LLC Need an Operating Agreement?
While the majority of U.S. states’ laws on LLCs do not make writing an operating agreement a necessity, you are wise to have one whenever starting a business. The operating agreement is a must-have because:
- It assists in making sure courts clearly see an owner’s liability protection and supports your LLC as a legitimate company.
- The agreement sets out how owners will be paid, decision-making processes, and ways to handle owners’ leaving or new owners being added.
- Assists in avoiding miscommunication between members about management and money.
- Craft your own operating guidelines rather than being subject to the default LLC laws of the state where you do business as the defaults may not be favorable to you.
How are LLCs Taxed?
A limited liability company is not a separate tax entity from its members. Thus, the LLC pays no taxes itself. It is the LLC owners that instead pay the taxes, with the amount to pay dependent on their allocated amount of profits or subtraction of their piece of the losses; this amount appears on their personal tax forms.
LLC members may decide to be taxed as a corporation. This is often done to reduce tax rates within the business on a significant amount of profits.
What are the Differences Between a Limited Liability Company and a Partnership?
The biggest way they are different is that owners of a limited liability company are not personally liable for business lawsuits or debts. This means:
- Creditors cannot seek payment from LLC owners for debts.
- But partners are typically not safeguarded against limited liability
- The exception is if they are in a limited liability partnership
Another difference is that LLC owners must file Articles of Organization under a formal process, paying the respective fee, and follow other filing guidelines of the state before operating the business. However, starting a partnership does not require any specific papers to be filed or certain dues are paid.
That being said, a major similarity of LLCs and partnerships is taxation. They are almost the same in this regard; owners file personal tax returns to show gains and losses, and the company does not pay tax on these funds.
Can I Convert My Existing Business to an LLC?
The short answer is “yes.” You can turn a sole proprietorship or partnership into an LLC to obtain personal property protection without altering the taxation structure of the company income. To do so:
- Fill out a straightforward form in certain states to convert the business to an LLC
- It is typically called a Certificate of Conversion
- If your state does not offer this form, then you go right to filing Articles of Organization instead
- Some states require you to publish a notice of intention to end a partnership and turn it into an LLC instead, publishing this announcement in a local newspaper
- Regardless of the state, you must transfer all licenses, ID numbers, and permits to the new LLC name
- This includes your state and federal employer ID numbers, sales tax permit, business license (or tax registration number), and professional permits or licenses
Partnerships vs. LLCs
If your new company has more than one owner, you may think about operating as a limited liability company or a partnership. Differences between these legal entities include the formation process.
Formation of General Partnership
- Form formally or informally
- There are many methods, such as verbally, written form, and court implied based on party activity (for example, sharing management responsibilities and both losses and profits)
- The ideal method is a written agreement or Articles of Partnership, but it is not a requirement
- This paperwork clearly defines partner roles and rights to help avoid court cases later
- In certain states, the certificate of partnership is mandated for a general partnership to be considered to exist
What is a Limited Partnership?
The majority of partnerships are limited partnerships because passive investors have limited liability with this structure. A limited partnership, or LP for short, has:
- At least one general partner and at least one limited partner
- General partners carry out management duties and are completely liable to partnership requirements (100 percent)
- Limited partners have no authority as managers and are not liable for the partnership rules; they are, therefore, shielded against debts and other requirements of the partnership
Formation of Limited Partnerships
A formal process is used to form an LD. It involves filing a certificate of partnership with the state division, which is typically the Secretary of State’s office. The process is more formal than a general partnership or LLC with co-owners because the owners must agree to an Operating Agreement that sets out the owners’ specific obligations and rights.
If it is an LLC, on the other hand, the owner(s) must file the Articles of Organization, which contains:
- The LLC name
- Its principal office location
- Owner names
- The foreseen length the LLC will exist
- Other legal requirements
A general partnership requires that:
- Each owner manages the business entity
- Each partner has one vote in decisions regarding the partnership, regardless of how much each partner invests
- Key business determinations come from majority votes
- So, partners can nudge co-owners to agree with their ideas for the business
- One or more partner be the daily operator of the general partnership
For a limited partnership, management by two or more owners is similar to a general partnership except:
- Limited partners have no management activities in the business
- Limited partners provide only investment capital
In a single-member LLC, you are responsible for the ownership, management, and operation of the company. It is your decision on how to run the business, strategize, and enact policies, without having to get the approval of anyone else. However, you do not get other viewpoints or experiences as you would with multiple owners.
If there are at least two owners, the Operating Agreement for the limited liability company will dictate the managers’ activities and roles, with the assignment being to the benefit of the company’s needs. You can either have all owners manage the LLC or specific owners do so in defined ways.
How monetary gains and losses are divided is almost the same for general partnerships and multi-owner LLCs.
- Both LLCs and general partners get equal shares of profits in their companies unless they have agreed to a different structure
- For limited partnerships, limited and general partners share profits and losses
- The amount given is dependent on the amount or percentage a partner invested in the organization
- LLCs, general partners, and limited partners can decide to divvy up profits and losses differently if they want within their business structure, entering into agreements that define these allotments
General partners in general and limited partnership models have full personal liability as they are the managers of their companies. The differences though are:
- Liability for their actions and the other partners fall upon general partners
- This is called joint liability or several liabilities
- Risks for limited partners are only the amount of capital they invested
- This is the same for LLCs and corporation shareholders
- Should a limited partner participate in business management activities, they are personally liable for those guidelines
- Limited liability company owners are not usually personally liable for LLC debts or legal cases against the LLC
- Only their investments to the LLC are in jeopardy
- But members can still be liable personally for their own actions if they hurt others, breach their duties, or guarantee loans personally
Obtaining the proper insurance and other policies is important for protecting an owner from liability to help keep his or her personal property and company resources safe.
Advantages of an LLC Compared to a Sole Proprietorship and a Partnership
- No personal responsibility on LLC owners for business debts
- Creditors can go after owners in partnerships or sole proprietorships to collect funds, whether it be from bank accounts or personal assets, such as cars or homes
- LLC owners are not generally liable for company debts; they are immune from creditors in this instance
- Limited liability companies can get monetary funds easier
- Ways to do so include adding members by selling membership interests and enacting more classes of membership interests that include voting and profit features
- Simpler to transfer ownership
- Just transfer ownership interests by selling to third parties without affecting company operations
- Partnerships and sole proprietorships cannot be fully sold
Disadvantages of an LLC Compared to a Sole Proprietorship and a Partnership
- Creation fees
- Beginning an LLC is more expensive than a partnership or sole proprietorship
- More paperwork
- There are no organizing guidelines for a sole proprietorship or partnership; not even a written agreement is necessary. An LLC, however, requires more organization to set it up
- Division of records
- Creating the separation of liability protection from the LLC for each member involves keeping precise records so that no confusion over money exist between the business and personal assets
LLC or LP: What’s Best for Your Business?
LLCs and LPs are amongst the most popular types of business entities. Any company can benefit from their structures, including pass-through means of taxation, less rigidity than other entities, limited liability, and defense against creditors. Under tax law, limited liability companies and limited partnerships are seen as general partnerships; however, they also have the limited liability benefits of corporations.
Deciding which one is optimal for your business involves considering:
- Tax repercussions
- Type of business
- Management control
- Other attributes specific to your type of company
Determining whether to create an LLC or a partnership can seem overwhelming. Reach out to the UpCounsel marketplace to get additional assistance with this venture when you post your legal need there. This marketplace connects you with lawyers who come from leading law schools, such as Yale Law, and have accumulated 14 years, on average, of legal experience thus far.