Choosing a proper business structure is one of the crucial steps encountered by owners in the initial stages of operating a company. One option is to structure the business as a limited liability company; another route is formation as a general partnership. Differences in tax liability, as well as personal liability for members regarding debts and other legal obligations, are the defining characteristics of what separate these designations.
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Formation and Ownership
LLCs and general partnerships differ in the method of formation and number of owners. Generally, an LLC is created by filing formation documents with the state business registrar, while a partnership is formed as soon as two or more individuals begin doing business together. An LLC may be owned by a single individual or multiple people. Owners of an LLC are known as members. In contrast, partnerships are owned by at least two individuals. As such, a sole business owner may not own a partnership.
An LLC is an independent legal entity, while a general partnership is a business that operates under the names of its owners. As an independent legal entity, an LLC may own property or enter into contracts separately from the owners of the business. LLC members are not usually personally liable for the debts or obligations of the business. On the other hand, partners in a general partnership are personally liable for the business's debts and obligations. When a partnership owns assets or owes money, the partners do as well.
In some cases, an LLC and a partnership are treated similarly by the IRS. The IRS does not recognize an LLC as a business entity, but instead requires LLCs to elect to be taxed as a corporation, partnership or sole proprietorship on tax returns. When the LLC has more than one member, it may elect to be treated as a partnership for tax purposes. Partnerships are considered disregarded entities, meaning they do not pay separate business income tax. Instead, partners report business income on their personal tax returns in proportion to their ownership of the business.
General partnerships and LLCs may be managed in a similar way. Each business type allows for a flexible management structure and permits business owners to decide how they want to separate responsibilities. In an LLC, members may draft an operating agreement to designate management duties and specify how profits will be distributed. Similarly, a general partnership may have a partnership agreement to specify the rights and responsibilities of each member.