Roles and structures of limited liability corporations and partnerships

LLC v Partnership

Two different forms of business organization are limited liability corporations (LLC) and partnerships. There are some significant differences between the two. Understanding these differences and their ramifications is essential to making the best decision for a new company that is just starting up.

A partnership is a form of ownership where the responsibility for the company is shared among two or more partners. The profits from such a company flow through to the income of the partners, so are taxed at the individual tax rates of the partners. The risk that the company has is also borne by the partners. Thus, there is unlimited liability on the ownership, as well as unlimited risk with respect to the profits or losses of the company. How this risk is portioned to the different partners is something that is outlined in the partnership agreement. Yet, it is worth noting that the partners are free to negotiate any arrangement they want, as long as it is understood that they must adhere to the terms of the arrangement.

Certain kinds of businesses are best suited for partnerships. Typically, partnerships are law firms, accounting firms and other such professional organizations. These organizations usually have limited downside risk, so the owners need not protect themselves from that risk in the organizational structure. In addition, these types of businesses benefit from the ability to structure the organization in whatever manner the partners want. Thus, the flexibility to utilize the partnership agreement is something that is a key attraction to partnerships for these types of firms.

A limited liability company (LLC) is a structure that is allowed by state, rather than federal, statute. Thus, it is conceivable that some states might not allow LLCs. The owners of LLCs "have limited personal liability for the debts and actions of the LLC." In this respect, the LLC has the feature of a corporation. However, in many other respects, an LLC functions more like a partnership. The tax structure of an LLC is flow-through, meaning that the profits and losses associated with the company are on the personal tax returns of the owners. The LLC is thus not taxed directly. In addition, an LLC also allows for a flexible management structure that the principles can tailor to meet their own needs. In that respect, an LLC functions just like a partnership.

It is worth noting that the IRS does not recognize an LLC for tax purposes. Thus, the LLC must also be a corporation, partnership or sole proprietorship. In order to receive the benefits of flow-through taxation, the LLC should also be a partnership or a sole proprietorship.

Depending on the state, there are further restrictions as to what sorts of businesses can be classed as LLCs. For example, in most states an LLC's members (owners) can include individuals, corporations, other LLCs and sometimes even foreign entities. There are usually rules against financial institutions being LLCs, however. They must be corporations, and there is no flow-through taxation option for them.

There are several factors that will go into the decision as to whether to select an LLC as the form of business organization or whether to be a partnership. The two are equal in some respects, such as the flow-through taxation and the flexibility to structure ownership in any way the owners see fit. Indeed, a firm can usually elect to be a partnership for taxation purposes, but an LLC for the purposes of liability.

Thus, with the key difference between these two forms of organization being the question of liability, the type of business is one of the most important elements. Law firms, for example, face few legal risks in part because of the nature of the business and the relatively low cost of defending against legal action. Most companies, however, face higher levels of risk in their business. A restaurant, for example, could face any number of violations and if a customer is poisoned could face steep liability costs. Therefore, the owners of any business that might conceivably face such high liability situations would be advised to adopt the LLC structure if it is allowed. Doing so would retain much of what would be gained from having a partnership or sole proprietorship but would limit the downside liability.