Choosing between a partnership and an LLC is a critical decision for any small business owner. Both structures offer unique benefits and potential drawbacks, making it essential to understand their key differences.
In this Partnership vs LLC article, we’ll explore how these two structures compare in terms of liability protection, tax implications, and management flexibility — giving you an idea of which one best aligns with your goals and operational needs.
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Partnership vs LLC: Overview
Before deciding which of these two entities is best for your business, it’s essential to have a basic understanding of what they are and how they work.
What Is an LLC
An LLC is a popular business structure that combines the liability protection of a corporation with the tax benefits and flexibility of a partnership.
LLC owners, known as members, are protected from personal liability for the company’s debts and obligations — meaning their personal assets are generally safe if the business faces financial trouble or legal issues.
Additionally, LLCs offer flexible management options and can choose how they want to be taxed, making them an attractive choice for many entrepreneurs.
What Is a Partnership
Partnerships are formed when two or more individuals agree to be co-owners of a business. In a partnership, each partner contributes to the business, whether through capital, skills, or labor, and shares in the profits and losses.
Partnerships are considered pass-through entities just like LLCs, with owners reporting all business earnings and losses on their personal tax returns.
However, unlike members in an LLC, partners in a general partnership do not have personal liability protection, as there’s no legal distinction between the owners of a partnership and their business. This means that their personal assets can be used to cover business debts and obligations.
With that said, partnerships are one of the most common entity types among small businesses due to how simple they are to establish and manage — particularly when compared to LLCs or corporations.
Note: While it may sound similar, a limited partnership is a completely separate business entity type.
Choosing Between a Partnership and an LLC
When deciding between a partnership and an LLC, several key factors need to be considered.
Below, we’ve highlighted the main areas in which these two structures differ to help you determine which one is the best fit for your needs.
Taxation
The IRS considers both partnerships and LLCs as pass-through entities, meaning owners of both are required to report their profits on their personal tax returns. They’re also both responsible for paying self-employment taxes.
The key way in which these two business structures differ is that partnerships can only be taxed in this way, whereas LLCs have a lot more flexibility. This is due to the fact that LLCs can elect to be taxed as either an S corporation or a C corporation if these designations are more favorable.
Ownership
There are also several notable differences between these two business entity types in terms of ownership structure. Namely, while LLCs can have one or multiple members, partnerships can be initiated only if there are at least two members.
Additionally, an LLC can have partnerships, corporations, or foreign individuals/businesses be its owners, while other businesses can’t act as partners in a partnership.
The final difference is that partnerships are governed by a document called a partnership agreement, whereas LLCs use an operating agreement instead.
Formation
A partnership is created when two people decide to form a business together. The partners aren’t required to file any paperwork with — or obtain any documents from — the local government in order to start conducting business.
In some states, you’re required to present a certificate or an official document to provide proof of your partnership. However, you and your partner(s) do need to register a trading name.
An LLC, however, must obtain a certificate of formation with the state where the business is organized. Additionally, this type of business entity must be registered with each state in which it conducts business.
To form an LLC, you must file Articles of Organization. Once you start your business, most states require regular record-keeping and reporting to keep an LLC in good standing.
Check out StateRequirement’s guide on How to Start an LLC.
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Liability
As the name implies, a limited liability company offers limited liability protection to its members against legal actions and business debts carrying over to their personal assets (e.g., car and house). This occurs because an LLC is treated as a separate legal entity to its owners.
With this protection, the personal possessions of the owners can’t be used to pay for any of the business’s debts. Each owner is only liable for business debts equivalent to what they invested in the company.
In a partnership, on the other hand, the owners are each fiscally responsible for business debts and can be held accountable for all business liabilities. This means the owners can be held personally accountable — and their personal assets used — to cover any business debts, lawsuits, and legal fees.
How to Convert a Partnership to an LLC
To change your partnership status to an LLC, there are seven key steps, you’ll need to complete, including:
- Selecting a State
- Naming Your LLC
- Appointing a Registered Agent
- Filing Your Articles of Organization
- Drafting an Operating Agreement
- Getting an EIN For Your Business
- Filing a BOI Report
If you’re interested in finding out more, we’ve covered everything you need to know about completing each of these seven steps in our How to Start an LLC guide.
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Partnership vs LLC FAQ
Should I register as an LLC or partnership?
Ultimately, this decision will depend on your business needs. An LLC provides limited liability protection and greater tax flexibility, while a partnership is much simpler to form. Alternatively, you may also want to consider a limited liability partnership (which needs one general partner and one limited partner).
You can read more about the differences between these two structures in our LLC vs Partnership article.
Can a partnership also be an LLC?
Yes. Owners are prone to liability as a partner, so they may choose to form an LLC and conduct their partnership business as an LLC. The LLC takes the full liability of the business, but shields the owners from personal liability.
Is an LLC taxed as a partnership?
Yes. A limited liability company (LLC) is taxed as a partnership. This is because the IRS doesn’t recognize an LLC as a taxable entity, but as a pass-through entity. Hence, a multi-member LLC would be taxed in the same way as a partnership.
For more information on this, you can see our guide on LLC Taxes.
How is an LLC similar to a partnership?
An LLC is similar to a partnership in that both structures offer flexible management and profit distribution options. In both, the owners or members can directly manage the business and share profits according to their agreements.
Additionally, both are pass-through entities for tax purposes, meaning the business itself is not taxed, but the profits and losses are reported on the owners’ personal tax returns.