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Thanks to their flexibility, personal asset protection, and relatively low maintenance, Limited Liability Companies (LLCs) have become increasingly popular with small business owners. But are LLCs considered partnerships?
As LLCs rise in popularity, prospective entrepreneurs have questions, so we're here to provide answers. To make the best decision for your business, let's dive into the intricacies of LLCs and their relationship with partnerships.
What Is an LLC?
An LLC is a popular business structure that combines the features of both a corporation and a partnership. LLCs provide their owners, who are known as members, with limited liability protection, meaning their personal assets are generally protected from business debts and liabilities.
In other words, if a company faces bankruptcy, lawsuits, or debt collection, the members of the company won't risk their personal assets — such as their houses, vehicles, and personal finances.
Is a Limited Liability Company the Same as a Partnership?
No, an LLC is not the same as a partnership. The primary difference between the two is that an LLC is an official business entity, but a partnership isn't. What do we mean by that?
An official business entity like an LLC must be formed by registering with the appropriate state government agency, usually the Secretary of State.
An unofficial entity like a partnership, however, requires no formal setup process. And since a partnership has two owners rather than one, it's considered the two-person version of a sole proprietorship.
And when an LLC has more than two owners, that doesn't make it a partnership, either — rather, it becomes a multi-member LLC vs. a single-member LLC.
Use the following cheat sheet to remember the key differences between LLCs and partnerships:
|An official business entity
|Provides personal asset protection
|Requires no formal setup
Are Owners of an LLC Known as Partners?
No, an LLC's owners are not known as partners.
One common misconception about LLCs is the terminology used to refer to their owners. While partnerships use the term "partners," an LLC refers to its owners as "members." This distinction is crucial, since partnerships typically involve shared personal liability between partners, while an LLC's members benefit from limited liability protection.
Does an LLC Classified as a Partnership Get a 1099?
The issuance of a 1099 form, also known as an information return, depends on the classification of the LLC for tax purposes. By default, the IRS treats multi-member LLCs as partnerships for tax purposes, and it treats single-member LLCs as disregarded entities (in other words, as part of the owner's personal tax return).
Partnerships, including multi-member LLCs, are generally required to file Form 1065, the U.S. Return of Partnership Income. This form allows the partnership to report its income, deductions, gains, and losses, but it doesn't mean that the partnership itself pays taxes. Instead, the profits and losses "pass through" to the individual partners in proportion to their ownership interests, and they report this information on their personal tax returns.
The individual partners may then receive a Form 1099-MISC from the partnership showing their share of the profits and losses, which they will use to complete their personal tax returns.
Both LLCs and partnerships may also receive Form 1099-K, depending on the services they were paid to provide and how much they were paid.
What Are the Four Types of Partnerships?
Partnerships come in various forms, so it's essential to understand each one before deciding which structure best suits your business's needs.
This is the most common type of partnership. In a general partnership, all partners participate in the business's day-to-day operations, share equal responsibility for the company's debts and liabilities, and split the profits and losses equally (or as outlined in the partnership agreement).
Limited Partnership (LP)
In an LP, there are two types of partners: general partners and limited partners.
- General partners have management authority and unlimited personal liability, and they are involved in the business's daily operations.
- Limited partners are more like passive investors with limited liability up to their investment amount. They are not involved in the business's daily operations and have no personal liability beyond their investment.
Despite their differences, both general and limited partners own a portion of the company and receive part of its profits.
Limited Liability Partnership (LLP)
LLPs provide limited liability protection to all partners, meaning they are not personally responsible for the partnership's debts or for liabilities arising from the actions of other partners.
However, each partner remains personally responsible for their own actions and professional misconduct.
Limited Liability Limited Partnership (LLLP)
An LLLP is a relatively new entity type that combines the elements of an LP and an LLP. It grants limited liability protection to all partners, including general partners, for the company's debts and obligations.
As is the case with LLPs, however, they may still have personal liability for their own professional negligence.
Is an LLC With Two Members a Partnership?
As we mentioned above, the IRS automatically treats multi-member LLCs as partnerships for tax purposes. Therefore, if an LLC has two or more members, it will be classified as a partnership unless the members choose otherwise by electing a different tax classification.
For example, members could elect to have the LLC taxed as an S Corp. If they do not file any such election, however, the IRS will simply tax the LLC as a partnership.
Is an LLC a Corporation or a Partnership?
As its own unique business entity, an LLC is neither a corporation nor a partnership.
Unlike a corporation, an LLC can't sell stocks on the public stock market. And unlike a C Corps, an LLC isn't subject to double taxation, which occurs when a company's revenue is taxed twice. The benefit of having an LLC instead of a corporation is that you won't be subject to the same degree of regulatory oversight, fees, or administrative responsibilities.
Another reason an LLC is not considered a partnership is that an LLC is an official business entity registered with the government, providing you with much more legal protection than a partnership would.
What Is the Most Common Type of Partnership?
The most common type of partnership is currently the general partnership.
Why? It's the simplest form of partnership and can be formed without a formal written agreement, although having a partnership agreement is highly recommended.
In a general partnership, all partners have equal authority and personal liability for the partnership's debts and obligations. While this type of partnership is relatively easy to establish, it also comes with the greatest personal liability risk for its partners.
So while a general partnership may be suitable for testing a business idea, we recommend filing a formal business entity as soon as possible (you can even form an LLC for free). If you don't, your personal assets will be on the line.
How Do I Choose Between an LLC and a Partnership?
To decide whether an LLC or a partnership is right for you, start by evaluating your individual wants and needs, as well as the state of your business.
For instance, if you haven't yet gotten concrete evidence that customers will pay for your products or services, you may prefer to test the waters with a partnership before committing to the cost and upkeep of forming an LLC.
On the other hand, if you want to protect your personal assets from business-related issues like lawsuits or creditors, you'll need to choose an LLC over a partnership.
Why Would Someone Want a Partnership Instead of an LLC?
In some cases, people might choose to start a partnership instead of an LLC because they don't want to go through the formal setup process (and pay the associated fees) an LLC requires.
The disadvantage of such a scenario is that all partners will be personally liable for the partnership's debts.
Is an LLC Owned by a Husband and Wife a Partnership?
Just like other multi-member LLCs, an LLC that's jointly owned by a married couple will be treated as a partnership by the IRS by default.
But if the couple lives in a community property state, they may be able to be treated as a single sole proprietorship instead.
How Is LLC Ownership Divided?
In general, an LLC's ownership is divided based on the amount of capital contributed by each member. If all members contributed equal amounts of capital, for instance, they would all receive an equal portion of the company.
And if each member contributed a different amount of capital, their ownership stake would be proportional to the amount they provided.
But thanks to the inherent flexibility of LLCs, each LLC's members can decide how they want to distribute ownership. And if they want, they don't have to take capital contributions into account at all.
For example, one person could provide the bulk of capital contributions, but they could still choose to split the LLC's ownership equally with the other members.
Can Partners Pay Themselves a Salary?
No, partners can't technically pay a salary to themselves. That's because, in a partnership, you can either be a partner or an employee, but not both.
So, how do you get paid? Instead of paying yourself a salary, you'll simply withdraw money from the business for your own personal use.
Does a Multi-Member LLC Need an EIN?
Yes, all multi-member LLCs must have an Employer Identification Number (EIN). That's true whether the LLC is taxed as a partnership — as all multi-member LLCs are by default — or has elected to be taxed as a corporation.
Make Your Business Official
If you belong to a partnership but haven't yet created a formal business entity, now's the time to do so — your home, car, and savings accounts would surely thank you if they could.
And with our $0 LLC service, forming an LLC won't cost you an arm and a leg. Just pay your state's registration fees and we'll take care of the rest.
Carrie Buchholz-Powers is a Colorado-based writer who’s been creating content since 2013. From digital marketing to ecommerce to land conservation, she has experience in a wide range of fields and loves learning about them all. Carrie is fond of history, animals and beauty in equal measure. In her free time, she enjoys knitting, playing video games and exploring Colorado's prairies and mountains with her husband.
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