LLC vs Partnership
The primary difference between an LLC and a partnership is the liability protections afforded to each. The LLC was created to be a hybrid of the partnership and corporation. So an LLC has the flexibility and ease-of-use of a partnership but with the limited liability protections of a corporation. That's the essence of the LLC. However, to fully grasp the difference between the LLC and a partnership, we first need to understand what a partnership is.
What is a Partnership?
A partnership is a business with two or more owners. LLCs and corporations can also have multiple owners, but partnerships are different in that they are not wholly separate entities from their owners. Because the business and owners aren’t legally distinct, partnership owners are generally personally liable for business debts.
That’s not to say that partnerships offer no liability protection. In some kinds of partnerships, certain owners may have liability protection from the business or one another—just not the across-the-board, entity-level protection of an LLC or corporation.
There are four types of partnerships:
When two or more people start a business together—but don’t file to create a formal business with the state—they have a general partnership. All partners are equals, and all partners are personally liable for any debts of the business.
A limited partnership is made up of two kinds of partners: general partners and limited partners. General partners are responsible for all of the day-to-day operations of the business. They are also liable for all business debts. Limited partners are silent partners who invest in the company but are not responsible for debts, liabilities, or decision-making. The limited partners share in profits but can only lose what they have invested. General partners, however, are on the hook for everything should the business go bankrupt or get sued by an angry customer.
Common with professional businesses like law firms, wealth managers, and medical professionals, an LLP protects its partners from the actions of one partner. For example, if three eye doctors form an LLP for their Lasik surgery practice, and one of the doctors messes up on a surgery, the other two doctors are insulated from any malpractice lawsuit. The rub, of course, is that if the LLP were to be sued as a whole, all of the partners would be liable, and their assets could be garnished to pay debts.
It is important to note that LLPs are not recognized as legal business structures in every state, and some states only allow certain professionals to form an LLP. For example, California, Nevada and New York only allow certain licensed professionals such as accountants, attorneys and architects to operate LLPs.
If an LP and an LLP had a baby, you’d get an LLLP. An LLLP allows for two types of partners; general and limited, like with an LP, but also offers liability protection from other partners like an LLP. It should be noted that less than half of states allow for LLLPs, which means if you’re going to go this route, you’ll want to doublecheck to make sure they are legal where you live.
Differences Between LLCs and Partnerships
While partnerships and LLCs are similar in that they allow two or more people to go into business together while sharing in the profits and losses, it’s important to understand the general differences between the two entities.
Formalities
- Partnerships: General partnerships don’t require formal paperwork or a registered agent to begin their existence. LPs, LLPs, and LLLPs will have to register with the state, and most states require them to have a registered agent. Most states also require that they file some sort of annual report.
- LLCs: LLCs file paperwork and register with any state where they do business. LLCs are also required to have a registered agent, and almost every state requires some sort of annual report or fee from the LLC.
Taxes
- Partnerships: Considered “pass-through” entities in the eyes of the IRS, profits and losses from the business are reflected on the partners’ personal income tax returns. The business itself pays no federal income tax.
- LLCs: An LLC that has at least two members will automatically be labeled as a partnership by the IRS. However, unlike a partnership, an LLC can elect to change the way it is taxed by choosing C corp or S corp taxation. This tax flexibility can allow LLCs to potentially save money.
Liability
- Partnerships: General partnerships are afforded zero limited liability, which means the assets of the owners are on the chopping block if the business gets sued or goes belly up. LPs, LLPs and LLLPs offer liability protection to some individual partners but not general partners or the business as a whole.Partners can also be held liable for contracts entered into by other partners, no matter whether the other partners were notified.
- LLCs: An LLC generally protects all the owners of the business from becoming personally liable for their company’s liabilities and debts, no matter how active a role a member plays. LLC members are also usually not liable for the bad actions of another LLC member.
Management
- Partnerships: General partners A limited partner in an LP has no role in the active management of the business, which is run by the general partners. General partners do not have the same liability protection as enjoyed by limited partners. General partners in case of a financial loss may be held liable for business debts.
- LLCs: Owners of an LLC are called members. An LLC can either be member-managed or manager-managed. LLCs have a great deal of flexibility in the way they structure management and decision-making within the company.
Why use a partnership instead of an LLC?
Partnerships are for people who want to own a business together, but don’t want to deal with all the formalities and paperwork that come with an LLC. In most cases, partnerships don’t adhere to the same rules as LLCs, which makes them easier and often cheaper to form. A general partnership can be as easy to form as a verbal agreement and a handshake (although we’d be remiss if we didn’t recommend a written agreement to accompany that handshake).
Should I convert my partnership to an LLC?
If you’re looking for liability protection, management options and tax flexibility, it might be time to convert your partnership to an LLC. However, there is no “best answer” when it comes to choosing a business structure. Partnerships are usually easier to form and run, while LLCs are generally better for entrepreneurs who crave the financial separation of their private assets from their business liabilities.
One thing to consider is that LLCs are recognized in every state in the US, as are general partnerships and LPs, but LLPs and LLLPs are a mixed bag when it comes to which states allow them and which do not. Prospective business owners need to weigh their options and make the best decision based on the needs of their business.
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