A limited liability company (LLC) is a popular legal business form, and it resembles a partnership in many ways. Before you decide whether an LLC or a partnership is better for your company, you should weigh the pros and cons of each.
Keep reading on to find out more about the similarities and differences between LLCs and partnerships.
What Is An LLC?
As a type of business legal entity, LLCs combine the liability protection of corporations with the operations of partnerships.
LLCs may have one or more owners, known as members. Every member owns a certain percentage of the business. LLC members operate the company under an operating agreement.
The members can hire a manager to handle the business’s day-to-day operations, or they can handle it themselves.
The limited liability company is sometimes mistakenly referred to as a corporation, even though it is not one. LLCs may choose to be taxed as corporations or S corporations, but they continue to function as LLCs.
What Is A Partnership?
Partnership refers to a business relationship among two or more people. Every partner makes a contribution to the business and has a share of the overall equity.
Partnerships operate under partnership agreements, and managing partners usually handle the daily administration.
Partnership And LLC Formation
A partnership and a Limited Liability Company are formed in very similar ways. In both cases, the business is formed by registering in the state it intends to operate.
Forming A Partnership
A partnership is a legal entity registered with the state. There are various kinds of partnerships that differ based on the partners’ professions and owners’ preferences regarding liability protection, management responsibilities, and investment.
As opposed to a corporation, which typically issues stock, partners share directly in the profit or loss of the company according to their percentage ownership.
Forming An LLC
An LLC is registered in a specific state, just like a partnership. The corporation files the articles of organization (in some states, referred to as a certificate of organization) to the state secretary.
Consult your state’s business division (usually the secretary of state department) if you are interested in forming a partnership since some states do not allow certain kinds of partnerships.
Debt And Legal Liability
The biggest difference between a partnership and an LLC is liability protection. While all LLCs qualify for this protection, only a few kinds of partnerships do.
Liability In Partnerships
The partners in a general partnership share responsibility for the partnership’s debts since they are all active participants in managing the business. Moreover, each partner is personally liable for any actions taken by the other partners. General partnerships aren’t very common because of this.
There are certain types of partnerships that offer liability protection. These protections are available in both limited partnerships and limited liability partnerships (not all states provide them).
Liability In LLCs
On the other hand, an LLC is set up primarily for the purpose of protecting its members from liability; therefore, the term “limited liability” is used in its name.
In most cases, the members of an LLC are only liable for the debts of the business that are within the limits of their individual investment.
When LLC Members Or Partners Can Have Personal Liability?
LLC members or partners in a limited partnership or limited liability partnership can be held personally liable in certain situations.
These cases illustrate how the corporate veil can be pierced, meaning that the separation between the company and the individual has been broken, thereby resulting in the company being held liable for the actions of a single member or more members.
Among these actions are:
- Putting personal and corporate assets together
- Abuse of authority or misconduct (fraud or activities that exceed the scope of a partner or member’s duties)
- Managing the LLC’s affairs improperly
Additionally, partners or members may be liable for specific business debts if they sign a contract to be responsible for them personally.
As an example, when an LLC purchases a building and a member of the LLC personally signs the mortgage guarantee, that member is personally liable for the loan if the LLC fails to pay.
In both partnerships and LLCs, taxation is “pass-through,” which means that the income taxes are passed along to the owners (members or partners) through their personal tax returns with either kind of business.
Taxes For Partners
Every year, a partnership files a Form 1065 partnership tax return; however, no tax is due by the partnership.
Instead, each of the partners is given a Schedule K-1, which shows how much each partner has earned or lost on shares during the year. The partner is then required to file this Schedule K-1 with their personal tax return.
Taxes For LLC Members
LLCs are not considered taxing entities by the Internal Revenue Service (IRS). Taxes on single-member LLC are the same as those on the sole proprietor, with Schedule C filed as part of their annual personal tax returns.
LLCs with multiple members are taxed in a similar way to partnerships, with income and losses passed through to each member’s personal tax return via Schedule K-1.
It is possible for LLCs to file an application for the IRS to be taxable as corporations or S corporations. In this scenario, the LLC continues to operate as an LLC rather than a corporation. For partnerships, this option of tax is not available.
Records For LLCs And Partnerships
A partnership, unlike corporations, does not have state-specific guidelines for recording partnership activities or keeping minutes of partner meetings.
The requirements for keeping records and holding meetings are different for LLCs. Speak with your attorney to find out what your state’s requirements are.
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