Multimember LLCs vs. Partnerships: How are they different?
7 min read
January 31, 2024 • Block Advisors
If you’re thinking about starting a business with multiple owners, you have options for how to structure the business. Two of the more popular choices are multimember LLC and partnership. If you’re wondering how LLCs vs Partnerships differ in how they are treated under state business laws and their IRS tax treatment, you’ve come to the right place. Read on to learn the nuances of each of these entity types.
State-level differences: multimember LLCs vs partnerships
To examine the difference between a multimember LLC and a partnership, we’ll first define each:
What is a multimember LLC?
A limited liability company, or LLC, is a formal entity structure set up under state statutes. LLCs can have an unlimited number of owners, called “members.” Members can be individuals, corporations, other LLCs, and/or foreign entities in most states.
One of the primary benefits of an LLC is that it offers owners limited liability protection.
What is a partnership?
A partnership is an agreement between two or more people to carry on a trade or business together, sharing profits and losses. Like an LLC, states do not restrict who can be a partner in a partnership. There is no maximum number of partners, but there have to be at least two.
There are 4 main types of partnerships:
- General Partnerships
- Limited Partnerships
- Limited Liability Partnerships
- Limited Liability Limited Partnerships
Partnership type is important because each is treated differently at the state level. The most common partnership type is General Partnership, so this article will focus on General Partnerships and how they differ from LLCs.
State-level treatment: LLCs vs partnerships
LLCs and General Partnerships vary in how they are formed and in how state governments treat them. Having a good understanding of the differences can help you choose the best way to form your business to support your personal and business needs.
There is a notable difference in how LLCs vs Partnerships are formed. An LLC is created by filing Articles of Organization with a state Secretary of State’s office. A General Partnership, on the other hand, is created when one or more parties agree to go into business together. This agreement can be verbal or in writing. The lack of formality can make partnerships attractive because they’re easy to create, but there are tradeoffs to consider, such as your liability as a partner or member.
Members in an LLC enjoy the benefits of limited liability protection. This means that, generally, a member will only be liable to the extent of their investment into the LLC.
Partners in a General Partnership don’t enjoy the same protection. A partner’s liability for the debts of the business isn’t necessarily limited to the partner’s investment in the partnership.
In addition to a partner’s personal assets being at risk, partners are “jointly and severally liable” for the debts of the partnership, which means that a creditor can choose which partner or partners to collect from when a debt is owed.
To illustrate, Amy and Jim own a landscaping company that they operate as a general partnership. They signed a five-year lease on an office space but went out of business after three years and stopped paying rent on the office space. To recover the rent due, the landlord can choose to pursue Jim or Amy individually or both together.
Some of the risks a partner bears can be mitigated by a well-crafted Partnership Agreement.
The governing documents that guide LLCs vs Partnerships are often similar in function but use different names. An Operating Agreement governs LLCs. This document lays out how the business will be run. The Operating Agreement may include things like how profits or losses will be split, how major decisions will be made, how ownership can be transferred, and how the business will be taxed. On the other side, General Partnerships are governed by their Partnership Agreement.
Whether these documents are required varies by state, but it is always good practice to have an agreement in place. This is especially true in states that have default rules that must followed when no written agreement exists.
Ways to manage LLCs vs Partnerships
One of the benefits of LLCs is that they are flexible in many ways including in how they are managed. LLCs have the option to choose to be member-managed or manager-managed. A member-managed LLC is run by the members themselves, whereas a nonmember hired by the members runs a manager-managed LLC.
A General Partnership is usually managed by the partners themselves (though a hired manager can also run it). Typically, each partner has the authority to act independently on behalf of the partnership in all matters unless limited by the Partnership Agreement.
Most states tax LLCs in the same way that they choose to be taxed on their federal return. General Partnerships, on the other hand, are taxed using the state’s partnership tax rules. Most states require the partnership to make a tax filing. A tax professional can help you understand what regulations would apply to your particular situation and understand the tax implications of LLCs vs Partnerships.
What structure is right for my business?
Learn about your options.
How does the IRS treat multimember LLCs vs partnerships for federal tax purposes?
LLCs and General Partnerships are also treated differently by the IRS. Tax treatment can be a significant consideration for how some owners choose to set up their business entity.
How are LLCs taxed?
The IRS does not recognize LLCs as an entity type for federal tax purposes. Rather, LLCs choose how they are taxed. Multimember LLCs have a few options to choose from:
- S Corporation
- C Corporation
If the LLC does nothing, it will be taxed as a partnership by default. This means that owners report income on their personal income tax returns and the business will file Form 1065, U.S. Return of Partnership Income.
An LLC may also elect to be taxed as an S Corporation or a C Corporation. In either case, the business is responsible for submitting a stand-alone tax return. LLCs taxed as C Corporations are subject to double taxation; S Corporations are not.
If an LLC chooses not to elect a non-default tax treatment, it will need to file the appropriate tax forms and follow the tax filing deadlines for that entity type (which may be different than the individual filing deadlines you’re used to). An LLC can change its tax classification later in its life cycle when certain requirements are met.
How are General Partnerships taxed?
General Partnerships are taxed as passthrough entities under Subchapter K of the Internal Revenue Code. This means that all the partnership’s income, losses, gains, deductions, and credits are claimed on the partner’s individual returns. Each partner’s share is determined by the Partnership Agreement or by the state’s default rules if there is no agreement. At tax time, the partnership will file Form 1065, U.S. Return of Partnership Income, which is an informational return. This return is generally due by March 15th.
The partnership will then use information from Form 1065 to generate a separate Schedule K-1s, Partner’s Share of Income, Deductions, Credits, etc., for each partner. Partners use the K-1 to report income on Schedule E, Supplemental Income and Loss of their individual return.
Navigating your options: LLCs vs partnerships
Whatever route you choose, to create an LLC, General Partnership, or another entity type, it’s important to consider the needs of your business, your partners, and your personal situation. Laws governing LLCs vs Partnerships may vary from state to state. This article is intended to be informative, but it is not legal advice or a substitute for legal advice. A business attorney can review your specific circumstances and guide your decisions.
At Block Advisors, we take pride in supporting you throughout your small business partnership journey. Our Small Business Certified Tax Professionals are available year-round, in person and virtually, to help your business thrive. Let our experts help you understand the potential tax implications of your choices, so you can optimize your company’s financial position.
This article is for informational purposes only and should not be construed as legal advice. You may want to seek the advice of an attorney to evaluate all relevant considerations.
About the Author
Carl Breedlove is a Lead Tax Research Analyst at The Tax Institute, H&R Block and Block Advisors’ center of tax expertise. He specializes in small business, rental property, and state taxation. Carl is a graduate of the University of Missouri-Kansas City School of Law with Master of Laws (LLM) and Juris Doctor (JD) degrees.