LLC vs. Partnership: What Is the Difference?
Deciding on the right structure is an important first step in setting up your business.
If you’re going into business together, whether it’s formal business partners, spouses, or family, knowing the difference between a traditional partnership and an LLC (or limited liability company) is important.
The primary difference between an LLC vs. partnership is that members of a partnership are personally liable for business debts, while members of an LLC are not.
However, the differences don’t stop there.
And, depending on your business’ structure, it can be more complicated than that.
Knowing how these two entities differ can help you make a smart decision for your business when it comes to choosing a structure
So, let’s dive in and see which is a better fit for you.
Table of contents:
- LLC vs. Partnership:
- Formation
- Liability
- Taxes
- Is an LLC or partnership better?
- Limited Liability Partnership: Can an LLC be a partnership?
- Partnership vs. LLC: Which Should You Choose?
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What Is An LLC?
An LLC, or limited liability company, is an official U.S. business structure designed to offer limited liability protection to the owners of the business.
This offers protection for the individual owners against things like lawsuits against the business and debt collection.
A limited liability company (LLC) is a business structure in the U.S. that protects the assets of its owners from lawsuits and creditors concerned with the company’s business debts.
While similar in terms of the liability protection to a corporation, an LLC doesn’t benefit from pass-through taxation like a true corporation.
What Is a Partnership?
A partnership is a business arrangement between two or more people with the intention to run the business jointly and share in profits.
A partnership can be split however the partners would like in terms of both the work to be done, money invested in, and how much each partner is paid out.
As opposed to an LLC, it’s less a formal business entity and more an arrangement for tax and profit purposes. This is why (as we’ll touch on later) you can be both a partnership and have limited liability depending on the partnership structure (an LLP or limited partnership).
LLCs vs. Partnerships: A Complete Breakdown
Now that we’ve taken a look at what an LLC and partnership are (as well as the primary difference between them), let’s dive a little deeper.
Below, we’ll break down three additional ways that LLCs and partnerships differ.
First, let’s talk about how to form each:
LLC vs. Partnership: Formation
Starting a general partnership vs. LLC is pretty similar, but there are some small differences. In both cases, you’ll need to register with your state to get the proper documentation.
Both entities have their own kind of agreements based on their ownership or membership percentages (how much of the business they own).
In the case of a partnership, there are several types of partnerships and types of partners you’ll need to choose from establishing your business. Partners and their share or percentage of the company and its profits are designated in a partnership agreement.
To form an LLC, you’ll have to create a similar agreement, referred to as an operating agreement, that details member percentages as well as other important details. To create an LLC you’ll also need to file articles of organization to finish setting up your business.
LLC vs. Partnership: Liability
As mentioned earlier, liability is likely the most important difference between an LLC and a partnership.
In the event that you can’t repay on a debt your business owes, for whatever reason, it’s nice to know that your business structure keeps you from being personally liable for those business debts. You don’t get that with a partnership.
But in the case of an LLC, that’s exactly what you get. Specifically, members of an LLC are only liable for those debts up to the personal investment they’ve made in the company.
However, there are scenarios where LLC members don’t qualify for that limited-liability protection and may be personally liable for a debt:
- If you and/or other members of the LLC have mismanaged business affairs
- If you and/or other members have conducted personal business in connection with the LLC (i.e. there is not a clear separation between the LLC and its member’s affairs)
- If members engage in illegal activity
- If members have personally guaranteed a loan
LLC vs. Partnership: Taxes
The difference between LLCs with multiple members and partnerships gets simpler when it comes to taxes: there is no difference.
Both multi-member LLCs and partnerships are considered pass-through entities by the IRS (single-member LLCs are taxed as sole proprietors), which means that the IRS doesn’t recognize either as a taxable entity, so taxes “pass-through” to its owner’s personal tax returns.
In addition to this, LLCs have the option to be taxed as a C corporation or an S corp, an option that partnerships don’t have.
Is an LLC or Partnership Better?
When it comes to comparing which is better, an LLC or partnership, it really comes down to two things:
- With an LLC, you get limited liability protection. Partnerships don’t.
- But LLCs cost more than partnerships to set up (and a bit more paperwork)
If you’re not worried about potential liability concerns, such as lawsuits being filed against your company (it all depends on the industry), a partnership might do the job.
However, in most cases, that added liability is a big bonus, and one that can really help you sleep at night.
It’s also worth noting that the cost of setting up an LLC is different in each state. Some states, such as California, cost a whopping $800 annually to maintain an LLC.
Limited Liability Partnership: Can an LLC Also Be a Partnership?
So far, we’ve talked about the differences between an LLC vs. partnership. But we’ve also touched on several similarities between the two, specifically multi-member LLCs.
That brings us to a common question: can an LLC be a partnership? The answer is yes, and it’s called a limited liability partnership.
In some states, you can set up your business as a limited liability partnership (or LLP). This isn’t a true LLC, in that you don’t have the same liability protection that an LLC affords you. However, it will give you protection against the actions of your partners.
Partnership vs. LLC: Which Should You Choose?
Which you’ll choose: partnership or LLC (or potentially LLP), mostly depends on whether you:
- Value liability protection for your business as a whole
- Desire liability protection against your partners (in the case of an LLP)
- And whether you’re willing to invest the additional time and money in setting up an LLC
The answer to those three items will help you decide which is better for you: multi-member LLC or partnership.
However, it’s important to consider other details such as the ability to change your tax structure with an LLC to that of either type of corporation (C corp or S corp).
While a partnership is rather simple and straightforward, an LLC is more complicated, and that can go both ways: more work, but more options that might be of value to you.
It’s also important to consider the long-term.
It’s hard to know where you’ll be in five years. But when choosing something like a business entity, it’s important to take a moment to consider where you project your business (and you) heading in the next several years and choosing an entity based on that.
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