LLC vs. Partnership

LLC vs. partnership: Liability for business debts

If you start a business with other people, you automatically have a general partnership. A general partnership is simple to set up and maintain, but you and your partners are each fully liable if the business is sued or can't pay its debts. For this reason alone, many business lawyers discourage general partnerships.

As an alternative, you can set up a formal business entity such as an LLC, limited partnership, or limited liability partnership. In each of these business types, at least some of the owners have limited personal liability. Business creditors can go after company assets, but the owners' personal homes, bank accounts, and other assets are safe.

• LLC. An LLC is not a partnership, though many LLC owners casually refer to their co-owners as “business partners." All LLC owners—known formally as “members"—are protected from personal liability for business debts.
• Limited liability partnership. Most states allow limited liability partnerships. Different states have different rules for such partnerships. Most allow limited liability for some or all of the partners, but some states hold partners liable for business debts or require at least one partner to be fully liable. And some states limit LLPs to certain professions.
• Limited partnership. A limited partnership has at least one general partner and at least one limited partner. The general partners run the company and remain fully liable for business debts. The limited partners are passive investors who cannot be involved in decision-making and aren't liable for company debts. Limited partnerships are mainly used in commercial real estate and other industries that need to raise money from a group of passive investors.

Some states have other partnership options, such as limited liability limited partnerships and professional LLCs. In general, LLCs offer the most liability protection, but certain professions may not be allowed to form LLCs in your state.

What is the difference between LLC and LLC partnership taxes?

An LLC can be a partnership for tax purposes because the IRS automatically classifies both LLCs and partnerships as “disregarded entities." This means that owners report their share of company profits and losses on their personal tax returns.

However, an LLC does have advantages over a partnership in that an LLC can also elect to be taxed as a corporation. Some LLC owners find that they can save money on taxes and boost their retirement savings by electing S corporation status. However, not all LLCs qualify to be taxed as S corporations.

Taxation is a complex and ever-changing topic. Consult an accountant to see whether you could see a tax benefit by organizing your business as an LLC as opposed to a partnership.

Organizing and running LLCs vs. partnerships

Both LLCs and partnerships are created by filing forms with the state. But there are some differences in the way the two business types are run.

An LLC doesn't require a general partner. Instead, it can be managed by its members or by a group of managers, with the other members acting as passive investors. The LLC operates according to its operating agreement form, a document that includes such things as how profits and losses are distributed, capital contributions of each member, how decisions are made, and the procedure for adding new members or dealing with departing ones.

An LLP operates similarly to an LLC, except that the governing document is a partnership agreement rather than an operating agreement. All partners can participate in running the company, or some partners can be “silent partners" who are simply investors.

In general, an LLC offers better liability protection and more tax flexibility than a partnership. But the type of business you're in, the management structure, and your state's laws may tip the scales toward partnership. A lawyer can help you sort through your LLC partnership options and choose the business type that's best for you.

LLC vs. partnership FAQs

What's the main difference between an LLC and a partnership when it comes to protecting my personal stuff?

An LLC protects your personal belongings (like your house, car, and savings) from business debts, while a general partnership doesn't. If your LLC gets sued or owes money, creditors can only go after the business' assets, not your personal property. But if you have a general partnership and the business gets in trouble, creditors can take your personal possessions to pay off business debts. 

Do LLCs and partnerships pay taxes the same way?

Both LLCs and partnerships use "pass-through" taxation, which means the business itself doesn't pay taxes. Instead, all the profits and losses go directly to your personal tax return, just like if you earned the money from a regular job. However, an LLC can choose to be taxed like a corporation, which might save money on taxes. This flexibility makes LLCs more attractive if you think your business might grow or if you want to save on self-employment taxes.

Which one is easier to set up and run?

A general partnership is easier to start because it happens automatically when two or more people go into business together—no paperwork required. An LLC requires you to file official paperwork with your state and pay filing fees, however, once set up, LLCs are often easier to manage. You can have all owners make decisions together, or pick one person to be the manager while others just invest money.

What happens if one of my business partners wants to quit?

This is where LLCs have a big advantage over partnerships. In a general partnership, if one partner leaves, dies, or goes bankrupt, the whole business usually has to shut down, unless you have a special agreement in place. With an LLC, the business keeps going even if one member leaves. The LLC exists as its own separate entity in the eyes of the law, so it doesn't depend on any single owner to survive.

Are there different types of partnerships I should know about?

Yes, there are three main types of partnerships beyond the basic general partnership. A limited partnership (LP) has two kinds of partners: general partners who run the business and are fully responsible for debts, and limited partners who just invest money and have limited responsibility. A limited liability partnership (LLP) is mainly for professionals like lawyers or doctors, and it protects partners from being responsible for their colleagues' mistakes. However, LLP rules vary by state, and some states don't allow them for regular businesses. LLCs are consistent and legal in all parts of the country.

Which should I choose for my business?

Choose an LLC if you want to protect your personal assets, need tax flexibility, or want to grow your business. Choose a partnership if you want something simple and cheap to start, and you're comfortable with the personal liability risks. Partnerships work well for low-risk businesses between trusted partners who plan to stay small. However, most business experts recommend LLCs because the extra protection and flexibility are usually worth the extra cost and paperwork.