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Differences Between Business Structure Entity Types

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The Differences Between Business Structure Entity Types

What are the differences between a partnership and a limited liability company?

When two or more people go into business together, they've automatically formed a partnership; they don't need to file any formal paperwork. By contrast, to form a Limited Liability Company (LLC), business owners must file formal articles of organization (sometimes called a certificate of organization) with their state's LLC filing office (usually the secretary of state or department of corporations) and comply with other state filing requirements.

Aside from formation requirements, the main difference between a partnership and an LLC is that partners are personally liable for any business debts of the partnership -- meaning that creditors of the partnership can go after the partners' personal assets -- while members (owners) of an LLC are not personally liable for the company's debts and liabilities.

There is one similarity between LLCs and partnerships, however. They both offer "pass-through" taxation, which means that the owners report business income or losses on their individual tax returns; the partnership or LLC itself does not pay taxes.

What are the Differences between a LLC, an S-Corporation and C-Corporation?

  1. Business Formality

With its roots as a C Corporation, the S Corporation involves structure, formalities and compliance obligations, which can be too burdensome for the solo entrepreneur, in other words, a “payroll of one.” If you incorporate as an S Corporation, you need to set up a board of directors, file annual reports and other business filings, hold shareholder’s meetings, keep records of your meeting minutes, and generally operate at a higher level of regulatory compliance than your business might need or want to deal with. With the LLC, this isn’t the case. LLCs just use an informal operating agreement.

What to know: If you want less red tape and formality, the LLC can provide greater simplicity.

  1. Who Can Be a Shareholder?

The S Corporation has more restrictions in terms of who can be a shareholder. For example, an S Corp cannot have more than 100 shareholders. Of course, this limitation is probably not of much consequence to many small businesses. In addition, all individual shareholders of an S Corp must be either U.S. citizens or permanent residents.

What to know: If you have foreign owners (or would like an LLC to be a shareholder), you cannot form an S Corporation and should opt for the LLC.

A corporation electing under IRC section 1362 to be taxed as an S corporation is subject to various ownership restrictions, including the requirement that shareholders must be individuals (section 1361(b)(1)(B)). Although very limited exceptions to this rule exist for entities such as estates and trusts, they do not address whether a limited partnership or a limited liability company (LLC) can be an owner. It would be reasonable, therefore, to conclude that the acquisition of an S corporation’s stock by a limited partnership or an LLC would immediately terminate the corporation’s S election.

However, letter ruling 200107025 recently stated that the acquisition of stock by a limited partnership and an LLC would not terminate a corporation’s S election. The ruling is very narrow and applies only to single-owner entities.

Notes:

  1. An LLC can file a tax return as a Partnership, S-Corporation, C-Corporation, or file a Schedule C on an individual tax return. It depends on the circumstances. See our article on “What Tax Return Do I File for an LLC?”
  2. Please note that there is a difference between forming and organizing a legal entity type for common businesses and a tax return entity type:
  1. Legal entities can be Sole Proprietor, Partnership, Limited Liability Company (LLC), S-Corporation C-Corporation, Professional Corporations, and Limited Liability Partnerships
  2. A tax return entity type can be an Individual Schedule C, Partnership, S-Corporation a C-Corporation

Partnership = Partners = General Partner, TMP (Tax Matters Partner)

LLC (Limited Liability Company) = Members, Managing Director

S-Corporations = Shareholders = Managing Director