Two or more individuals who join in a business enterprise—each of whom shares in profits and losses and contributes money, property, and labor or skill—comprise a partnership. There are two forms of partnerships: general and limited.
Profits and losses are “passed through” to partners’ personal tax returns, hence their being referred to as “pass-through” or “flow-through” entities. Partnerships file taxes on Form 1065, U.S. Return of Partnership Income, and report each partner’s portion of net profits and losses on the form’s Schedule K-1, Partner’s Share of Income, Deductions, Credits, etc. Using the information from Schedule K-1, they report their net profits and losses on Form 1040, U.S. Individual Income Tax Return.
Due to their increased need for accounting and legal services, partnerships are more costly to establish and operate than sole proprietorships.
Each general partner can participate in decision making that affects the business as a whole and is binding on their partners (such as taking out loans) if their partnership agreement permits.
In a general partnership, partners own and operate a business together and share its liability. Like sole proprietors, general partners’ assets can be seized to satisfy a debt.
Partners performing services for their trade or business are considered to be self-employed, rather than employees of the partnership. General partners’ net earnings from self-employment include their distributive share of income or loss from the trade or business, as well as guaranteed payments, per the IRS.
A limited partnership is comprised of both general and limited partners. Limited partners are simply passive investors in the business and thus are not entitled to decision-making power nor subject to the same liabilities, whereas general partners are owners and operators for the business and shoulder its liability.
Limited partners’ taxable net earnings from self-employment include guaranteed payments for their services provided to or on behalf of the partnership but exclude earnings from their distributive share of partnership income, per the IRS.
Limited Liability Partnership (LLP)
In a limited liability partnership, general partners are not liable for their partners’ misconduct or negligence, making the structure more befitting to those with a professional practice.
Unlike a limited partnership, all partners participate in the management of a company.
It is a formal business entity and, as such, requires a written partnership agreement as well as filing an annual report with the Secretary of State in order to renew registration.
Limited Liability Company (LLC)
An LLC is a hybrid business entity fusing the more well-liked features of partnerships and S corporations; like an S corporation, earnings and losses pass through to the owners (called “members”) and are included on their personal tax returns, preventing double taxation. Like a partnership, members’ liability for an LLC’s debts and actions is limited.
Note that although owners of an LLC are typically referred to as members, they are sometimes called shareholders. While this is correct in that they possess ownership in the company, this is different than a shareholder of a corporation; while corporate shareholders obtain their ownership of the corporation through the purchase of stock, an LLC does not have the ability to issue stock. An LLC’s shareholders are thus simply members with a personal ownership interest in the LLC.
A domestic LLC with at least two members is legally considered a partnership unless it specifically elects to be treated as an S corporation by filing Form 8832, Entity Classification Election. Individual owners of single-member LLCs that operate a trade or business are considered sole proprietors for tax purposes, and are therefore subject to taxation of net earnings from self-employment.
An LLC can have one of two management structures: a manager-managed LLC, in which one person runs the business; or a member-managed LLC, in which each member can have different percentages of ownership, voting power, and profits and losses.
LLCs are not required to hold annual meetings or record meeting minutes.
They are not constrained in the number of shareholders/owners they may have.
Single-member LLCs are permitted in most states.
LLCs lack the permanence of a corporation; they can only form for a limited period of time. Some states require their dissolution after 30 years.
An LLC must file articles of organization with the Secretary of State in which they form, and some states also require signing an operating agreement (similar to a partnership agreement).
Some businesses, including banks and insurance companies, are barred from becoming an LLC, and foreign LLCs are subject to special regulations.
LLCs, like (domestic) partnerships, must file Form 1065, U.S. Return of Partnership Income.