Business is more complicated than just finding a new idea and establishing a company. The legal foundation of your business affects more than just the way you file your taxes. The inherent effect of having more than one owner can be drastic on a business. The two primary choices for structuring a business are partnerships and LLC. But, which one is better?
Identifying the best type of partnership for your business can be a rather difficult task for most businesses as each business is different with different needs. However, establishing a difference between the major types can help make an informed choice. Hence, we will enumerate the difference between a partnership and an LLC.
Businesses with more than one partner are, by default, regarded as partnerships. However, the partnership agreement varies based on the type. The basic types of partnerships include:
General Partnerships (GP)
General partnerships are the easiest to form and the easiest to dissolve. A simple, straightforward signing is required to make the business official. The state does not require explicit registration. A GP divides profits equally among all the partners unless explicitly mentioned otherwise. As a result, all partners have equal power to make company decisions about contracts and financing. If the company bankrupts, the owners are equally liable for the debts owed by the company. Moreover, they are not employees of the company and take an owner’s share.
Limited Partnerships (LP)
Limited partnerships require the company to register with the state. Hence, they are liable to follow the state laws regarding the agreement, company name, partner duties, and annual reporting duties. LPs are for those who wish to seek investors but do not want to deal with more complicated compliance issues associated with other partnership types. The company should have at least one general partner and one or more limited partners. The limited partners do not interfere with the daily operations of the company. The daily operations are handled by the general partner(s). The limited partners are not liable to the company’s debts and liabilities.
Limited Liability Partnerships (LLP)
LLPs are not universally recognized in all the states. Some might even require you to register as a PLLP. All the partners of an LLP must belong to the same profession. As the name suggests, the liability is limited in an LLP with equal responsibility assigned to each partner. The amount of personal liability varies according to the state. There is also another type popular in the real estate industry referred to as Limited Liability Limited Partnership (LLLP).
These were the basic types of partnerships. However, there is another form of business structure.
Limited Liability Company (LLC)
LLC is a formal business structure registered with the home state. The organization is liable to uphold the rules and regulations presented by the state. The primary difference between a partnership and an LLC is that the LLC owners are not considered as a part of the company and are not responsible for its debts and liabilities. Instead, the owners are regarded as ‘members.’ There is no limit to the number of members in an LLC, and most states recognize an LLC with one member. For this reason, many sole entrepreneurs prefer an LLC for the protection it provides. In its essence, an LLC is a hybrid of a corporation and a partnership.
The management flexibility provided by an LLC is one of its key advantages. The company can be managed by a fellow member or a manager appointed by the members. A significant difference between a partnership and an LLC is the requirement to fill fees for each state that the business expands to. Most states also require an LLC to pay annual fees and an annual franchise tax (for LLCs expanding to different states.)
Another major difference between an LLC and a partnership is the tax filing procedures. The profits generated in an LLC are passed down as members’ personal tax returns. The passed down taxes are subject to self-employment tax and income tax. LLC and GP partners are not considered employees and do not receive paychecks.
On the other hand, partnerships use the company’s reports on income, profits, losses, deductions, etc., to calculate taxes. Then, the individual partners use this information to report their share of the profit/loss and file each tax return.
Every business has its unique needs and demands. Every partner wants to manage their business in their own way. Hence, it is highly difficult to choose the ideal option based on external perspectives. So, the best advice is to gather the potential partners and discuss whether the liability protection offered by an LLC is worth the extra fees and paperwork. Identify the key differences between a partnership and an LLC unique to your business and make an informed choice