When more than one entrepreneur come together to establish a business, the most popular legal structures they choose for their company are either a Limited Partnership or an LLC due to their flexibility in terms of management, limited liability and pass-through taxation.
Let’s learn about the difference between these two popular structures so you can choose the one that’s right for you.
What is a Limited Partnership?
A Limited Partnership is a business structure that combines features of a limited company with that of a partnership for use as a tax shelter, but does not create a legal entity separate and distinct from its owners. It is usually formed by at least one general partner (or full partner) and at least one limited partner (or nominal partner).
Limited partners contribute capital and share in the profits while one or more general partners operates the business. General partners remain personally liable for partnership debts and risks while limited partners incur no liability with respect to partnership obligations beyond their capital.
Advantages of a Limited Partnership
- a Limited Partnership makes it less difficult to attract investors because limited partners have limited liability to the business debts.
- Profits and losses pass through the business to the partners, who end up being taxed on their own personal income tax returns.
- Being a limited partner puts a limitation on liability with respect both to potential lawsuits and money; the limited partner is only going to be liable for the amount of capital it contributed to the business; a business creditor cannot come after the limited partner’s personal assets.
- Limited partners get to share in the profits and losses without having to participate in the business itself.
Disadvantages of a Limited Partnership
- If the limited partner becomes active in the business he or she may have general-partner personal liability.
- General partner is personally fully liable for the debts of the business.
- Certificate of Limited Partnership must be filed with the state before the partnership comes into existence, which includes state filing fees.
What is a Limited Liability Company (LLC) ?
A Limited Liability Company (or more commonly referred to as “LLC”) is a distinct type of business that offers an alternative to partnerships and corporations, by combining the corporate advantages of limited liability with the partnership advantage of pass-through taxation (earnings are taxed only once). LLCs are governed by the individual states and are recognized in all states. Owners of the company are referred to as members, who cannot be held personally liable for the company’s debts or liabilities.
Advantages of an LLC
- Involves less administrative paperwork and record keeping than a corporation.
- No double taxation: much like a sole proprietorship or partnership, LLCs are treated as a “pass-through” entity for tax purposes. This means that LLCs avoid double taxation.
- Members are fully exempt from personal liability for business debts and obligations.
- Unlike S-corporations which cannot have more than 100 shareholders, an LLC can have a virtually unlimited number of stockholders.
Disadvantages of an LLC
- An LLC has to be dissolved upon the death or bankruptcy of a member.
- Not ideal if your goal is to become a publicly listed company at some point.
- Profits are subject to social security and medicare taxes.
- Some states exempt corporations from property tax, but not other entities, including LLCs.
The bottom line
While both Limited Partnership and LLCs share some commonalities but differ in their legal liabilities and business obligations and have some advantages and disadvantages that you need to consider. How you structure your company is essential from a legal and tax perspective but ultimately, your decision on which structure to choose may depend largely on your business type and goals.