An S Corporation Vs. a Partnership: Pros & Cons

By Mark Kennan

Whether you choose to run your business as an S corporation or a partnership has a number of significant effects, especially in management and taxes. A partnership is an association of people who run a business together. An S corp is a corporation or limited liability corporation that made a special election to allow the owners to take advantage of pass-through taxation while still maintaining the benefits of limited liability.

Formation

Forming a partnership doesn't require any paperwork. In fact, you can create a partnership without even intending to do so if you and another person start working together on a business. An S corp, on the other hand, requires more complex registration requirements. First, the business must register as a corporation or limited liability corporation in the state in which it's doing business, which generally requires creating either articles of incorporation or articles of organization. Then, the company must complete IRS Form 2553 to make the S corp election.

Structure Flexibility

Partnerships offer more flexibility in terms of the structure of the company, both in management and profit and loss allocations. The default provision is that all partners have an equal say, regardless of ownership share, but the partners can agree to another arrangement. For example, partners could agree that one partner will act as the managing partner and make all the day-to-day decisions, or the partners could all maintain an equal say in all decisions. In addition, partners can also contract for different shares of profits and losses, regardless of ownership interest. S corps, on the other hand, are more rigid. S corp shareholders elect a board of directors that oversees the management of the company, and they appoint officers to oversee the day-to-day operations. In addition, S corp allocations of profits and losses must be made on the basis of shares owned and no alterations can be made.

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Personal Liability

General partnerships expose all the partners to unlimited personal liability, which means that all the partners are jointly and severally liable for any debts incurred by the partnership. For example, if one of your partners runs over a pedestrian while on a delivery and a court finds the partnership liable, you could lose your personal bank accounts and other personal assets to satisfy the judgment. S corp owners have limited liability, which means their personal assets typically aren't at risk if the S corp has financial difficulties.

Tax Treatment

If you're a member of a partnership, the IRS considers your income self-employment income. This means you're responsible for paying self-employment taxes in addition to income taxes. Because they're self-employed, partners don't have any money withheld by an employer, which means they typically must make estimated tax payments. S corps, on the other hand, are more complicated. S corp owners must pay themselves a "reasonable salary" for the work that they do for the business. This amount counts as employee income, which means the S corp owner receives a W-2 form. The remainder of the income from the S corp passes through to the owners and is taxed at ordinary income tax rates.

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Which Is Better: an LLC or an LLP?
 

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The Definition of an LLC Member

An LLC member is an owner of the company. All owners of LLCs are classified as members. Just as the owners of a partnership are members of the company, LLC owners are legally members of the LLC. The rights and responsibilities of LLC members are specified in the operating agreement, but also defined by state LLC regulations. Since LLCs are state, not federal, creations, each state can have their own specific regulations, but owners in all LLCs are members.

Difference Between LLC & LLP

An important aspect of starting a business is choosing which type of business entity to create. Two popular business entities are limited liability companies, or LLCs, and limited liability partnerships, or LLPs. Each entity has unique characteristics, but both are also similar in many ways, including the way they are taxed by the IRS.

General Partnership Laws & Regulations

A partnership is a form of business entity owned by more than one partner. The key consideration is that the business is conducted with the aim of making a profit. Most partners enter into a formal written partnership agreement, setting out their rights and obligations, but a partnership can operate effectively on the basis of a handshake. Each state has its own laws relating to partnerships but the general principles remain the same across the United States.

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