4 Tax Implications of an LLC vs. Partnership

When you file taxes as a business, you need to determine what type of entity your organization is. The IRS has guidelines on the qualifications for each kind of tax entity.

Two of the most popular tax entities are limited liability companies (LLCs) and business partnerships. If you are trying to decide between these two, we have more information to help you determine which one is right for your circumstances.

Limited Liability Company (LLC)

A limited liability company (LLC) is a popular type of business entity. It is easy to apply for, and every state, including the District of Columbia, recognizes LLCs. An LLC can be a group of people or a single-owner LLC.

All you need to do is file the proper documents with the appropriate state agency and pay for filing fees to qualify as an LLC.

Limited liability companies are popular because they shield the personal assets of the owner. For example, if your business is in debt, the bank cannot seize your personal property. The only exception to this rule is if you signed a personal guarantee to finance a business venture.

As a result, a limited liability company provides much of the same legal protections as a corporate structure, just with more management flexibility and simpler taxes.

Business Partnership

A business partnership, like the name implies, involves more than one business owner. It is defined as a business operation between two or more individuals where they share management responsibilities and profits.

The federal government recognizes different types of partnerships, including general partnerships. Partnerships are traditionally more complicated with regards to taxes since multiple individuals are involved.

For example, the IRS does not generally consider partnerships as being separate from their owners. Therefore, they are comparable to limited liability companies in that they are considered “pass through” entities.

“Pass through” entities allow profits and losses generated by the business to pass through the business to the partner. It avoids the frustrations of double taxation that most corporations face.

Limited Liability Companies vs. General Partnerships

Limited liability companies and general partnerships have a lot of similarities. A limited liability company actually pays income tax based on the partnership system. However, there are a few noticeable differences as well. Let’s examine some of the tax implications of creating an LLC vs. partnership:

#1 Determining Dividends

A limited liability company and a partnership are both formed the same way. You register the entity with the state.

However, partnerships have an additional responsibility. They also must determine what type of business partnership they wish to fall under. Secondly, the partnership needs to determine the percentage share of each partner.

Profits and losses are directly transferred to owners in a partnership, unlike a corporation. The distribution of profits and losses is typically laid out in an initial agreement. The percentages will affect how each partner is taxed.

#2 Determining Liability

The biggest tax difference between an LLC and a partnership is surrounding liability protection. 

Members of an LLC are potentially liable for debts of the business as well as lawsuits against the business. However, in most circumstances, their personal property is protected.

Meanwhile, in a general partnership, the liability for debts of the business fall on each partner. Furthermore, each partner is responsible for the personal liability of all other partners.

One way you can protect yourself from legal liability is to create a “limited partner.” A limited partner can invest in the business, but is not allowed to participate in day-to-day management.

#3 Pass Through Entities

Partnerships and LLCs are both considered pass through entities. For tax purposes, the company does not pay its own taxes like a corporation does. Instead, all of the profits and losses are passed through the company and to the respective members or owners.

Pass through entities are not subject to double taxation like a corporation is. However, it is still the responsibility of each member or owner of the LLC/partnership to report their share of profits or losses on a personal income tax return. If one member fails to file, or files incorrectly, it could jeopardize the entire business.

#4 Record-Keeping

Both a partnership and a LLC must register the entity with the correct state agency. However, a partnership is not required to keep records of partnership activities or minutes of partnership meetings. The only stipulation is to make sure you have a quality partnership agreement/operating agreement in place.

Meanwhile, an LLC must maintain strict separation from the personal affairs of the members. This is known as a “corporate veil.” When a corporate veil is not followed, members of the LLC can become personally liable for the activities of the business.

Therefore, an LLC does have some requirements for keeping records and minutes. Speak with a tax professional or accountant to help keep you from exposing yourself to liability.

Limited Liability Partnership

If you still have questions about which tax entity to register as, you may want to reach out to a tax professional. Another option is to form a limited liability partnership.

Levy & Associates has worked with limited liability companies and partnerships for years. We can help you determine which entity is best for your organization as well as assist with common filing errors that result in higher taxes.

Contact us at www.www.levytaxhelp.com, or call 800-TAX LEVY to learn more. 

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There’s never a good time to be audited, and the time-consuming process will take away from your business or family if you try to face it alone. Let us handle and coordinate communication, so you can return to your daily life.