A partnership is a business that two or more people own together.
Each partner contributes to the financial and/or operational side of the company, and in return, they’re also personally responsible for some or all of the profit and losses.
There are four types of business partnerships:
- LLC partnership (also known as a multi-member LLC)
- Limited liability partnership (LLP)
- Limited partnership (LP)
- General partnership (GP)
So why would you form an LLC partnership over, say, a limited partnership? Let’s dive into how these four business entities work and the pros and cons of forming each kind.
LLC partnership (Multi-member LLC)
A limited liability company (LLC) can have one owner or multiple owners, who are called members. LLCs with multiple members are called multi-member LLCs or LLC partnerships.
Under an LLC, members have a legal shield between their personal assets and the business, meaning they generally can’t be sued for the company’s actions or debts. However, they can be held liable for the actions of another member, especially if they knew the member was negligent or made management decisions that led to a lawsuit.
Keep in mind that the amount of liability protection LLCs offer can differ depending on your state. Make sure you understand your state’s rules and requirements before choosing a business entity.
The benefits of forming an LLC partnership include:
- Personal liability protection: Members receive legal protection between the business’s actions and debts and their personal assets.
- Tax flexibility: LLCs can elect to change their default tax classification and be taxed as an S corp or C corp.
- Corporate members: An LLC can have a corporation as a member. Other types of partnerships can’t be owned by other businesses, only individuals.
- Anyone can form an LLC: Some partnerships can only be formed by certain professions, like lawyers, accountants, and architects. An LLC can be formed by most types of businesses.
A major drawback to forming an LLC partnership is that members can be held responsible for the actions of other members.
Types of businesses that typically form LLC partnerships: Companies whose owners want liability protection from the business while still being involved in the day-to-day management and operations. Since LLC partnerships can be formed by most types of businesses, they’re generally a good fit for most people.
Limited liability partnership (LLP)
A limited liability partnership (LLP) is a type of partnership where the owners aren’t held personally responsible for the business’s debts and obligations or the actions of other partners.
This generally means you can’t lose your personal assets if someone takes legal action against your company, unless you’ve personally done something wrong. However, partners can be held liable for their own negligence, if they personally did something wrong, or engaged in malpractice.
Like an LLC partnership, the liability protection you receive under an LLP varies from state to state. Always check your state’s rules before forming an LLP.
The benefits of LLPs include:
- Liability protection from other members’ actions: Unlike other types of partnerships, partners in an LLP could have personal liability protection from both the business’s debt and other partners’ negligence (depending on the state).
- Easy to add or remove partners: Using an LLP partnership agreement, you can decide how much each partner is paid from the business and easily add or remove partners. (This is also a benefit of an LLC.)
- Management flexibility: Partners decide how much they want to be involved in the operational and managerial side of running the company, and involvement won’t affect their personal liability. Remember, partners of an LLP are only liable for their own behavior. So even if they’re making decisions about the company with another partner, they’ll only be held responsible for their own actions.
The drawbacks of forming an LLP include:
- Only available to certain professions: In some states, only approved professions can form an LLP, such as lawyers, doctors, accountants, and architects.
- No tax flexibility: LLPs can’t change their tax treatment, meaning they’ll only be allowed to get taxed as a partnership.
- Only individuals can own an LLP: While other partnerships can have a corporation as an owner, LLPs can’t.
- Recognition in other states: Rules regarding LLPs vary by state and some states won’t recognize LLPs formed in other states. This can impact the liability protection that LLP owners have if an issue arises in another state. So if your business operates in multiple states, this might not be the best option.
Types of businesses that typically form LLPs: Professions that are allowed to form LLPs vary state to state, but some examples are accountants, lawyers, architects, chiropractors, doctors, and dentists.
Limited partnership (LP)
When it comes to limited partnerships (LPs) there are two types of partners: general partners and limited partners.
- Limited partners don’t make business decisions but usually provide startup funding and capital. Sometimes they’re called “silent partners.”
- General partners help manage the company and make business decisions.
An LP must have at least one general partner and one limited partner.
- The general partner is personally accountable for the entire business, including its debts and the actions of other partners.
- The limited partner is not personally responsible for the company since they have no decisionmaking power.
The primary benefit of an LP is that the limited partner receives legal protection regardless of their financial contributions or ownership percentage. This could make a business more attractive to investors who have the capital to put into a company but don’t want to take on the risk of actually running it.
Other benefits of an LP are:
- Decisionmaking power: The general partner retains their decisionmaking power while benefiting from the financial contributions of the limited partner.
- Corporate partners: A corporation can be a partner of an LP, giving general partners more opportunities for investors.
A drawback of an LP is that a limited partner can lose their limited partner status if they become too involved in the management of the company. “Too involved” can mean signing legal contracts on behalf of the business, making management decisions, and carrying out business activities.
So if the limited partner doesn’t like the way the business is being run, they have little say in the matter. It also means that the limited partner doesn’t need to be consulted about business decisions, which may not be for everyone.
For the general partner, the drawback of an LP is that general partners are personally responsible for the business. There is no legal protection between the general partner’s personal assets and the business.
Types of businesses that typically form LLPs: Companies with financial backers who don’t want to be part of the daily management or operations.
General partnership (GP)
Unlike other types of partnerships, general partnerships don’t require you to register with the state, and don’t even require a formal agreement. If you and another person conduct business together, you default to being a general partnership.
General partnerships offer no personal liability protection.
That means each partner is legally responsible for the business’s debts and actions. If the company is sued or can’t pay its financial obligations, the partners’ personal assets are at risk. This also means partners are liable for each other’s actions. (Choose your business partners wisely!)
The benefits of a general partnership are:
- Easy to form and low-cost to run. Since there’s no state registration, you don’t pay for the costs of forming a business entity or the ongoing registration fees.
- Tax flexibility: Partnerships can ask to be taxed as a corporation using Form 8832: Entity Classification Election.
- Corporate partners: Like an LLC and LP, general partnerships can be owned by both individuals and corporations.
The drawbacks of a general partnership include:
- No personal liability protection: If your business is sued or has outstanding business debts, your personal assets are at risk.
- Partners are liable for each other’s actions: If your business partner is sued, you can be sued with your partner. If your partner is sued individually but can’t pay the damages, the claimant can potentially collect money from you.
Types of businesses that typically form LLPs: Companies who don’t want to register with the state and partners who are comfortable sharing personal liability for their business.
Comparing the 4 partnership types: LLC vs. LLP vs. LP vs. GP
Whew, we just talked a lot about the differences between the four types of business partnerships.
Here’s a quick chart that summarizes these comparisons. Keep in mind that rules may vary depending on your state.
|Number of owners||1+||2+||2+||2+|
|Type of owner||Member||Partner||General partner and limited partner. (You’re required to have at least one of each.)||Partner|
|Personal liability protection from business||Yes||Yes||For limited partners, yes. For general partners, no.||No|
|Liability protection from other partners’ actions||No||Yes||General partners could be held liable for each other’s actions. Limited partners are not liable.||No|
|Default tax classification||For single-members, sole proprietor. For multi-members, partnership.||Partnership||Partnership (Only general partners pay self-employment tax. Limited partners are exempt.)||Partnership|
|Management structure||All members can manage||All partners can manage||Only general partners can manage||All partners can manage|
|Who can form one||Anyone||In some states, only certain professions||Anyone||Anyone|
|Required to register with the state||Yes||Yes||Yes||No|
How are business partnerships taxed?
A multi-member LLC, LLP, and LP are not recognized as taxable entities by the IRS and therefore are automatically taxed like a general partnership.
All four partnerships are pass-through entities, which means that the profits are passed on to the partners’ tax return. The business doesn’t pay taxes, but the partners do. The amount of profit allocated to each partner is determined by a partnership agreement.
At tax time, the partnership files:
- Form 1065: U.S. Return of Partnership Income, where it reports its total income, expenses, and profit or losses.
- Schedule K-1 for each partner, reporting their share of the income or losses. This information is used on the partner’s personal tax return.
Partners pay two types of taxes on the income reported on the K-1: self-employment tax and income tax. Self-employment tax is 15.3 percent and generally applies to 92.35 percent of the partner’s net income. Income tax varies based on the partner’s tax bracket.
The only type of partner that doesn’t pay self-employment tax is the limited partner of an LP. General partners of an LP do pay self-employment tax because they’re involved in the day-to-day decisionmaking. Since limited partners don’t play an active role in daily business operations, their income isn’t considered “earned income” that’s subject to self-employment tax.
Multi-member LLCs, LPs, and general partnerships can choose to be taxed as corporations by submitting IRS Form 8832 to the IRS. Multi-member LLCs can also elect to be taxed as an S corp by submitting IRS Form 2553.
How do I pay myself as a partner?
If you’re a partner, you can pay yourself by taking a portion of the profits your business earns as an owner’s draw. The amount of your draw will be determined by your business’s profits and your partnership agreement, which states how much of the profits each partner is entitled to.
Unless your partnership is taxed as a corporation or S corp, you cannot pay yourself as a W-2 employee.
Keep in mind that partnerships are pass-through entities, which means that even if you don’t take money out of the business, you’re still responsible for paying taxes on your portion of the profit.
Let’s say your partnership has $100,000 in taxable profit at the end of the year. You and your partner each own 50 percent of the business. Your portion of the profit is $50,000. Throughout the year, you only take $25,000 out of the business as a draw.
Are you taxed on the $25,000 you took out or $50,000, which is your share of the profit?
You’re taxed on $50,000 because, as a pass-through entity, you pay taxes on the profit that is allocated to you, not the profit that is distributed to you.
Now that you know the pros and cons of each type of partnership, you’re one step closer to fulfilling your dream of starting a business with your business partner by your side.