What is a partnership?<\/h3>\n\n\n\n
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.<\/p>\n\n\n
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<\/figure>\n<\/div>\n\n\nThere are 4 main types of partnerships:<\/p>\n\n\n\n
- \n
- General Partnerships<\/li>\n\n\n\n
- Limited Partnerships<\/li>\n\n\n\n
- Limited Liability Partnerships<\/li>\n\n\n\n
- Limited Liability Limited Partnerships<\/li>\n<\/ul>\n\n\n\n
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.<\/p>\n\n\n\n
State-level treatment: LLCs vs partnerships<\/h2>\n\n\n\n
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.<\/p>\n\n\n\n
Formation<\/h3>\n\n\n\n
There is a notable difference in how LLCs vs Partnerships are formed. An LLC<\/a> is created by filing Articles of Organization with a state Secretary of State\u2019s 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\u2019re easy to create, but there are tradeoffs to consider, such as your liability as a partner or member.<\/p>\n\n\n\n
Limited liability<\/h3>\n\n\n\n
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.<\/p>\n\n\n\n
Partners in a General Partnership don\u2019t enjoy the same protection. A partner\u2019s liability for the debts of the business isn\u2019t necessarily limited to the partner’s investment in the partnership.<\/p>\n\n\n\n
In addition to a partner\u2019s personal assets being at risk, partners are \u201cjointly and severally liable\u201d 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.<\/p>\n\n\n\n
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.<\/p>\n\n\n\n
Some of the risks a partner bears can be mitigated by a well-crafted Partnership Agreement.<\/p>\n\n\n\n
Governing Document<\/h3>\n\n\n\n
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.<\/p>\n\n\n\n
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.<\/p>\n\n\n\n
Ways to manage LLCs vs Partnerships<\/h3>\n\n\n\n
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.<\/p>\n\n\n\n
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.<\/p>\n\n\n\n
State Taxation<\/h3>\n\n\n\n
Most states tax LLCs in the same way that they choose to be taxed on their federal return<\/a>. General Partnerships, on the other hand, are taxed using the state\u2019s 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.<\/p>\n\n\n\n
<\/div>What structure is right for my business?<\/h3>
Learn about your options.<\/p>
\nBlock Advisors Business Formation<\/a><\/div>\n<\/div><\/div><\/div>\n\n\n\nHow does the IRS treat multimember LLCs vs partnerships for federal tax purposes?<\/h2>\n\n\n\n
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.<\/p>\n\n\n\n
How are LLCs taxed?<\/h3>\n\n\n\n
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:<\/p>\n\n\n\n
- \n
- Partnership<\/li>\n\n\n\n
- S Corporation<\/li>\n\n\n\n
- C Corporation<\/li>\n<\/ul>\n\n\n\n
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<\/em><\/a>, U.S. Return of Partnership Income<\/em>.<\/p>\n\n\n\n
An LLC may also elect to be taxed as an S Corporation<\/a> or a C Corporation<\/a>. 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.<\/p>\n\n\n\n
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<\/a> for that entity type (which may be different than the individual filing deadlines you\u2019re used to). An LLC can change its tax classification<\/a> later in its life cycle when certain requirements are met.<\/p>\n\n\n\n
How are General Partnerships taxed?<\/h3>\n\n\n\n
General Partnerships are taxed as passthrough entities under Subchapter K of the Internal Revenue Code. This means that all the partnership\u2019s income, losses, gains, deductions, and credits are claimed on the partner\u2019s individual returns. Each partner\u2019s share is determined by the Partnership Agreement or by the state\u2019s default rules if there is no agreement. At tax time, the partnership will file Form 1065<\/em><\/a>, U.S. Return of Partnership Income<\/em>, which is an informational return. This return is generally due by March 15th<\/sup>.<\/p>\n\n\n\n
The partnership will then use information from Form 1065 to generate a separate Schedule K-1s, Partner\u2019s Share of Income, Deductions, Credits, etc.<\/em>, for each partner. Partners use the K-1 to report income on Schedule E<\/a>, Supplemental Income and Loss<\/em> of their individual return.<\/p>\n\n\n\n
Navigating your options: LLCs vs partnerships <\/h2>\n\n\n\n
Whatever route you choose, to create an LLC, General Partnership, or another entity type, it\u2019s 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.<\/p>\n\n\n\n
At Block Advisors, we take pride in supporting you throughout your small business partnership journey. Our Small Business Certified Tax Professionals<\/a> 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. <\/p>\n\n\n\n
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.<\/em><\/p>\n\n\n\n
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