The Limited Liability Company (LLC) is a popular business legal form, and it has many similarities to the partnership legal form. In fact, an LLC pays income tax as a partnership. But there are some differences between an LLC and a partnership that you should consider before deciding on which is better for your new business. The owners of a partnership are partners, and there may be different types of partners. The owners of an LLC are called members.
FORMING AN LLC
Like a partnership, an LLC is formed in a specific state. The business files articles of organization (in some states, a certificate of organization) with the state’s secretary of state. Most LLCs function under an operating agreement, which defines member percentages and answers other “what-if” types of questions.
· If a member engages in fraud or illegal activities goes beyond the scope of the duties of a member.
· If one or more members has or does mismanage the affairs of the LLC.
Members of an LLC are also liable for specific debts of the LLC if they personally sign to be responsible for those debts. For example, if an LLC purchases a building, and an LLC member signs a personal guarantee for the mortgage, the member is liable for the loan if the LLC can’t pay as agreed.
TAXES IN PARTNERSHIPS AND LLCS
Partnerships and LLC are “pass-through” taxing entities. That is, the taxes are passed through to the owners (partners or members) on their personal tax returns.
· Taxes for Partners. A partnership files a partnership tax return every year on Form 1065, but no tax is due by the partnership. Instead, a schedule K-1 is given to each partner, showing the amount of the partner’s share of the profits or losses for the year. Then, the partner files this schedule K-1 with his or her personal tax return.
· Taxes for LLC members. LLCs are not recognized by the IRS as a taxing entity. So multiple-member LLCs are taxed in the same way as partnerships passing though the income or loss to each member’s personal tax return using the Schedule K-1. Single-member LLCs are taxed as sole partnerships, filing a Schedule C along with their personal tax returns. LLCs may choose to be taxed as a corporation or an S Corporation. Partnerships don’t have this tax option.
Profit and Loss Distribution
For both business entities, profits and losses are distributed directly to the owners. Unlike a corporation, there are no stock holders and no stock is offered to owners.
Registration and Record-Keeping
Partnerships and LLC are both registered with a state and both should have an operating document (partnership agreement or LLC operating agreement).
Records for Partnerships
Unlike corporation, partnerships have no specific state meetings.
Records for LLCs
LLCs must maintain strict separation from the members’ personal affairs, sometimes called a corporate veil. If the separation isn’t strictly kept, the LLC members may be become personally liable for LLC activities. An LLC has some requirement to keep records and to hold meetings. Check with your attorney to see what the requirements for your state LLC and partnerships formed in a state may be.
Liabilities in Partnerships and LLCs
The difference in liability protection is the single biggest difference between partnerships and LLCs. Partners or LLC members can be liable for debts for the business and for lawsuits against the business.
· Liability in Partnerships. In a general partnership, each partner has personal liability for the debts of the partnership. In addition, each partner has personal liability for the actions of all the other partners. Some partnerships may include limited partners who have invested in the business but who don’t participate in the day-to-day management of the business.
· Liability in LLCs. In contrast, an LLC is set up specifically to provide Liability protection to its members, hence the term “limited liability”. If the LLC maintains its separation from the personal affairs of the member, LLC members are only liable for the debts of the business entity to the extent of their personal investment.
There are some circumstances when LLC members can have personal liability. If there is no clear separation between the business and the individuals.
· If a member engages in fraud or illegal activities goes beyond the scope of the duties of a member.
· If one or more members has mismanaged the affairs of the LLC.
Members of an LLC are also liable for specific debts of the LLC if they personally sign to be responsible for those debts. For example, if an LLC purchases a building, and an LLC member signs a personal guarantee for the mortgage, the member is liable for the loan if the LLC can’t pay.
Taxes in Partnerships and LLCs
Partnerships and LLCs are “pass-through” taxing entities. That is, the taxes are passed through to the owners (partners or members) on their personal returns.
· Taxes for Partners. A partnership files a partnership tax return ever year on Form 1065, but no tax is due by the partnership. Instead, a Schedule K-1 is given to each partner, showing the amount of the partner’s share of the profits or losses for the year. Then, the partner files this Schedule K-1 with his or her personal tax return.
· Taxes for LLC members. LLC’s are not recognized by the IRS as a taxing entity. So, multiple-member LLCs are taxed in the same way as partnerships, passing through the income or loss to each member’s personal tax return using the Schedule K-1. Single member LLCs are taxed as sole proprietors, filing a Schedule C along with their personal tax return. LLCs may choose to be taxed as a corporation or an S Corporation. Partnerships don’t have this tax option.
· Records for Partnerships. Unlike Corporations partnerships have no specific state meetings. Partnerships and LLCs are both registered with a state and both should have an operating document (partnership agreement or LLC operating agreement).