LLC vs Limited Partnership (What’s the Difference?)
Once you decide to open a business, a limited liability company or a limited partnership are two options you may form as an entity.
As a Mergers and Acquisitions specialist, I assisted several entrepreneurs with business formation. To provide clarity and guidance, I'll share my insights on LLCs and limited partnerships based on formation, management, liability, documentation, and taxation.
Together with my team of business experts, we aim to help you make an informed decision and avoid any unnecessary hassle.
Quick Summary
- An LLC provides personal liability protection to all its members, while the same security is only afforded to the limited partner in a partnership.
- Both entities benefit from pass-through taxation, but differ in terms of structure, formation, and legal compliance
- As of 2020, there are 4.2 million partnerships in the United States, 10.5% of which are limited partnerships, according to the U.S. Bureau of Economic Analysis.
- In my years in the industry, l've learned that both entities are ideal for small businesses, but an LLC offers more benefits.
LLC and Limited Partnership Compared
A limited liability company, or LLC, and a limited partnership are business structures ideal for small industries. While both benefit from pass-through taxation, they differ in terms of liability protection, structure, management and operation.
An LLC is a business structure that offers liability protection, single taxation and flexible management and operation procedures [1].
A limited partnership is a legal business arrangement between a general or managing partner and a limited partner or investor.
Key Differences
A limited liability company and limited partnership differ in terms of the following:
1. Formation and Structure
To form a limited liability company, you need to file Articles of Organization, appoint a registered agent, apply for an EIN, create an operating agreement, and obtain the necessary licenses and permits.
Depending on the state, an official publication might be required before you can operate your business legally. That's why I always advise clients to inquire with the Secretary of State to determine whether it applies to their location or not.
A partnership can be formed without formally filing the entity, but it cannot obtain legal benefits if it is not registered. If the parties in a partnership decide to register the firm, it would ensure legal compliance and credibility.
To form a partnership, you need to choose and register a partnership name or DBA, draft and sign a partnership agreement, and comply with tax and regulatory requirements.
2. Management
An LLC has the option to collectively manage the company or appoint members to run and manage the business. The company may opt to employ an independent individual or management service to oversee the LLC.
For clients new to the business, I recommend employing an LLC manager or professional service on the first year to familiarize yourself with the responsibilities of the position.
The general partner in a limited partnership assumes all managerial responsibilities, as well as running the day-to-day operations of the business entity. The limited partner acts as a passive investor with no administrative duties.
"A partnership is not a legal contract between two equal individuals. It’s an emotional alliance between two people committed to each other’s success."
- Warren Buffet, Investor & Philanthropist
3. Liability Protection
LLC members are provided with personal liability protection, in that, any debts, losses or other legal actions against the company are limited to the business entity. Banks and creditors may not pursue the personal assets of LLC members to settle claims.
In a limited partnership, personal liability protection is only extended to the limited or silent partner, and only the initial investment may be subject to loss. The general partner assumes personal liability for all debts, losses and legal actions against the business entity.
4. Documentation
An operating agreement is an internal document that outlines the by-laws of an LLC, which includes management, operations, ownership percentage, and the rights and responsibilities of the members.
The transfer of ownership, as well as the admission on new members are also indicated in the operating agreement.
A partnership agreement is a voluntary contract that defines the terms and conditions by which a limited partnership is managed and operated by the parties involved in the business.
It is executed with the understanding that there will be a sharing of the profits and losses among partners.
5. Taxation
An LLC is taxed as a pass-through entity by default, wherein the company itself does not pay taxes at the business level. The taxes are reported and paid on the member's individual returns [2]. According to the IRS, this tax structure is chosen by approximately 90% of LLCs, highlighting its popularity due to the tax benefits it offers.
Members can choose to be taxed as a corporation. A client of mine was subjected to double taxation when she opted for a C corp tax status.
Partnerships also feature pass-through taxation. The business is not taxed at the corporate level, all profits and losses flow through the individual partners who pay on their annual tax return.
Related Articles:
- Difference Between a Partnership and an LLC
- Filing Taxes for a Partnership LLC
- Setting Up A Partnership LLC
What Are the Advantages and Disadvantages of an LLC?
Here are the benefits and disadvantages of an LLC to help you decide if it is the best option for your business.
Advantages:
- LLC members benefit from personal liability protection, wherein the assets of the company are separate from the finances and properties of the owners. While this is true, I emphasize the importance of opening a business bank account to legally separate personal finances from company assets and prevent piercing the corporate veil.
- Members are not subjected to double taxation.
- An LLC has a flexible management structure, since the members have the option to operate the company or appoint a professional service to run the LLC.
Disadvantages
- If an owner decides to leave or retire, the transfer of ownership should be agreed upon by all members.
- An LLC cannot exist perpetually like a corporation. Once the purpose of the business has been fulfilled, the members can voluntarily dissolve the LLC.
What Are the Advantages and Disadvantages of a Partnership?
A limited partnership offer the following pros and cons:
Advantages
- A prospective partner can help you raise capital to start a business.
- Limited partners benefit from personal liability protection.
- A partnership is relatively easy to establish since it has fewer formation requirements.
Disadvantages
- A limited partner cannot participate in the company's day-to-day operations and management decisions.
- A general partner does not benefit from limited liability protection.
FAQs
How Is Ownership Interest Determined in a Limited Partnership?
In a Limited Partnership, the ownership interest is determined based on the partnership agreement. Two common models for partnership agreement are used: the capital contribution model, which assigns ownership based on contributed funds, and the management model, which considers involvement in running the business.
Is a Limited Partnership the Same as a Limited Liability Partnership?
A Limited Partnership (LP) and a Limited Liability Partnership (LLP) are not the same. While an LP has general and limited partners with differing liabilities, an LLP provides limited personal liability for all partners, who can also actively participate in management.
Can a General Partner and a Limited Partner Be the Same Person?
A general partner and a limited partner can be the same person. If a limited partner becomes the manager, they automatically become a general partner as well, assuming both positions.
References:
- https://taxfoundation.org/tax-basics/pass-through-business/
- https://www.irs.gov/businesses/small-businesses-self-employed/limited-liability-company-llc
