Partnerships vs LLCs
Partnerships and LLCs have several aspects in common, so they’re frequently lumped together in articles and discussions. However, there are some important distinctions between these forms of business, including liability, state registration, tax options and more.
General Partnerships, LPs, LLPs and LLLPs
Before comparing the similarities and differences between LLCs and partnerships, it’s important to note that there are several kinds of partnerships. Each type of partnership functions a bit differently, particularly regarding liability.
- General partnership: 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.
- Limited partnership (LP): A limited partnership has two different kinds of partners: general partners and limited partners. The general partners run the business and are personally liable for any debts of the business. Limited partners, on the other hand, are essentially passive investors. They put money into the business and receive some of the profits. However, they don’t have a voice in business decisions, and they don’t have personal liability.
- Limited liability partnership (LLP): In a typical LLP, the business itself doesn’t have limited liability, but the partners are protected from the liabilities of other partners. What does that mean? Imagine a dental office with several dentists, all partners. If one partner is sued for malpractice, only that partner is liable—the other dentists are protected. However, if the LLP itself were to be sued by creditors, all the partners would be liable, much like in a general partnership.
- Limited liability limited partnership (LLLP): LLLPs are fairly new and not yet recognized in all states. Basically, they’re a combination of an LP and an LLP. LLLPs have general and limited partners like an LP. General partners are also protected from the liabilities of other partners like in an LLP.
Differences Between Partnerships and LLCs
On the surface, partnerships and LLCs may appear to function similarly, but there several key differences.
The terminology is different for owners of partnerships and LLCs. An owner of a partnership is (unsurprisingly) called a partner. An owner of an LLC is a called a member.
As the name suggests, a partnership requires at least two partners. An LLC, however, can consist of a single owner.
In a general partnership or LLP, partners are typically on equal footing when it comes to managing the business. The partners have shared decision-making authority. In an LP or LLLP, however, only general partners can run the business. Limited partners don’t have any management authority (and if they attempt to assert authority, they can lose their limited liability).
LLCs are more flexible when it comes to management. An LLC can choose to be member-managed or manager-managed. A member-managed LLC runs similarly to a general partnership with shared decision-making authority among members. In a manager-managed LLC, managers make the day-to-day decisions. Members don’t have a say in these decisions, but they do have the power to vote out a manager.
As described above, general partnerships don’t have any limited liability. LPs, LLPs and LLLPs all have some degree of limited liability. Either the partners have unequal liability (like general and limited partners in an LP or LLLP) or liability is limited to protection from other partners (like LLPs and the general partners in LLLPs).
However, none of these partnerships gives every partner equal limited liability from debts against the business—like in an LLC. In an LLC, all members typically receive liability protection, no matter how active their role in the business may be.
Forming an LLC always requires filing paperwork with the state, typically a document called the Articles of Organization. General partnerships, however, are created when partners begin to do business together—they don’t require formal paperwork to begin their existence (although they do have to obtain any business licenses or permits required by their state, county or municipality).
LPs, LLPs and LLLPs, on the other hand, are more a bit more like LLCs. These partnerships generally require initial state paperwork. Most often, this an application for a Certificate of Limited Partnership (or Certificate of Limited Liability Partnership, etc.).
State reporting requirements, such as annual reports, usually apply to LLCs. (Note that there are a few odd states, like Arizona, where the state has an annual report but doesn’t require LLCs to file one.) General partnerships, on the other hand, aren’t usually required to file any annual, biennial, or periodic reports with the state.
For other types of partnerships, however, reporting requirements vary state to state. For instance, states like Alaska, Arizona and Delaware require regular reports for LLPs/LLLPs but not limited partnerships. Many other states—including Arkansas, Florida, Illinois, Massachusetts, North Dakota and Washington—require annual reports from limited partnerships as well.
It probably doesn’t come as a surprise that the IRS tax classification of a partnership is…partnership. A partnership files an informational return with the IRS (Form 1065), but the business itself doesn’t pay tax on its income. Instead, profits pass through the company to individual partners. Partners then report profits on their individual tax returns. Partners actively involved in running a partnership must also pay self-employment taxes.
Single-member LLCs are considered “disregarded entities” by the IRS and are taxed like sole proprietorships. Multi-member LLCs are taxed as partnerships by default—but they have the option to file for a different tax election with the IRS. LLCs can choose to be taxed as C corporations or S corporations. As a result of this flexibility, LLCs have the potential to save money on taxes by choosing the tax designation that best fits their particular business.
Of course, there are plenty of other differences between partnerships and LLCs that are specific to certain entity types or areas. For instance, some states allow for different types of LLCs, such as benefit or series LLCs. Some states have franchise taxes that affect LLCs and sometimes LPs, LLPs, or LLLPs as well. Overall, however, the list above illustrates the primary differences between partnerships and LLCs.