A Comparison of LLC, Partnership and Corporation

Gabi · Joined: 06 May 2004 Posts: 2

As you can see from the title, this article will give you a comparison between the three following components: LLC, Partnership and Corporation. But before that let's see what the definition of the three terms is.
Let's see the first definition. What LLC means? This abbreviation stands for Limited Liability Company. It is a type of company, authorized only in certain states, whose owners and managers receive the limited liability and (usually) tax benefits of an S Corporation without having to conform to the S corporation restrictions. The basic definition of an LLC is a business structure that is a hybrid of a partnership and a corporation. Its owners are shielded from personal liability and all profits and losses pass directly to the owners without taxation of the entity itself. By definition, an LLC offers its owners the advantage of limited personal liability (in this case it is just like a corporation) and a choice of how the business will be taxed, making particularly popular with small businesses. Partners can choose for the LLC to be taxed as a separate entity (again, like a corporation) or as a partnership-like entity in which profits are passed through to partners and taxed on their personal income tax returns.
Although state laws governing creation of LLCs and IRS regulations controlling their federal tax status are still evolving, because of their flexibility LLCs are increasingly regarded as the small business legal entity of choice. And there are a few questions, which are often asked about this type of company. Let's have a look at them…
The most often asked question is how many members (he owners are called "members." There are no shareholders in an LLC) are needed to form a LLC? The answer is that unlike a corporation which can have as few as one shareholder, most states require that an LLC consist of two or more members (owners). Recently, however, more states are allowing single-member LLCs. Please note, however, that the IRS may treat a single person LLC differently than an LLC with more than one member.
Another question is whether you have to hold LLC meetings, or not. Although a corporation's failure to hold shareholder or director meetings may subject the corporation to alter ego liability, this is not the case for LLCs in many states. In California, for example, an LLC's failure to hold meetings of members or managers is not usually considered grounds for imposing the alter ego doctrine where the LLC's Articles of Organization or Operating Agreement do not expressly require such meetings.
And the last question is How long does an LLC endure? The answer here is as follows. Although many states now allow an LLC to have a perpetual existence, LLC's traditionally were required to specify the date on which the LLC's existence will terminate. In most cases, unless otherwise provided in the articles of organization or a written operating agreement, an LLC is dissolved at the death, withdrawal, resignation, expulsion, or bankruptcy of a member (unless within 90 days a majority in both the profits and capital interests vote to continue the LLC).
Now, let's see the definition and basic information about the next component –the partnership. It is a type of unincorporated business organization in which multiple individuals, called general partners, manage the business and are equally liable for its debts; other individuals called limited partners may invest but not be directly involved in management and are liable only to the extent of their investments. Unlike a limited liability company or a corporation, in a partnership the partners share equal responsibility for the company's profits and losses, and its debts and liabilities. The partnership itself does not pay income taxes, but each partner has to report their share of business profits or losses on their individual tax return. Estimated tax payments are also necessary for each of the partners for the year in progress. Partnerships must file a return on Form 1065 showing income and deductions. Estimated tax payments are also required if they expect their income to be greater than $1,000.
One big advantage of a general partnership is that you don't have to register with your state and pay an often hefty fee, as you do to establish a corporation or limited liability company. And because a general partnership is normally a "pass through" tax entity (the partners, not the partnership, are taxed unless you specifically elect to be taxed like a corporation) filing income tax returns is easy. Unlike a regular corporation, there is no need to file separate tax returns for the corporate entity and its owners. But given that the business-related acts of one partner legally bind all others, it is essential that you go into business with a partner or partners you completely trust. It is also essential that you prepare a written partnership agreement establishing, among other things, each partner's share of profits or losses, day-to-day duties and what happens if one partner dies or retires.
As you already learnt, there are tax implications to owning a partnership interest. In this paragraph you will read a few more things about these tax implications. First, the business income of a partnership is divided between the partners and included on each partners' personal income tax form; the partnership does not file a separate tax form. Second, if the business has suffered a loss, the partners can deduct the loss from any other employment income they receive. This will lower the overall income of an individual partner and reduce the amount of income tax he or she must pay. Third, if the business has made a profit, the profits are taxed at each partners' personal income tax rate. Fourth, because the partnership is not a separate legal entity, the partners cannot take advantage of income splitting or tax deferral opportunities available with corporations.
A major disadvantage of doing business as a general partnership is that all partners are personally liable for business debts and liabilities (for example, a judgment in a lawsuit). While it's true that a good insurance policy can do much to reduce lawsuit worries and that many small, savvy businesses don't have debt problems, it's also true that businesses which face significant risks in either of these areas should probably organize themselves as a corporation or LLC. Because a partnership is based on the individual partners, and it is not a separate legal entity, if one of the partners dies, the partnership ends. This means that the remaining partners have to re-establish the partnership, which can be considered a disadvantage.
And now, here comes the definition of the third component in this article – the corporation. It is the most common form of business organization, and one which is chartered by a state and given many legal rights as an entity separate from its owners. This form of business is characterized by the limited liability of its owners, the issuance of shares of easily transferable stock, and existence as a going concern. The process of becoming a corporation, call incorporation, gives the company separate legal standing from its owners and protects those owners from being personally liable in the event that the company is sued (a condition known as limited liability). Incorporation also provides companies with a more flexible way to manage their ownership structure. In addition, there are different tax implications for corporations, although these can be both advantageous and disadvantageous. In these respects, corporations differ from sole proprietorships and limited partnerships.
As most of the types of business, the corporation also has its advantages and disadvantages. Let's have a look at some of them… first, the advantages.
One of the key reasons for forming a corporation is the limited liability protection provided to its owners. Because a corporation is considered a separate legal entity, the shareholders have limited liability for the corporation's debts. The personal assets of shareholders are not at risk for satisfying corporate debts or liabilities.
The second advantage is that since a corporation is a separate legal entity, it pays taxes separate and apart from its owners (at least in the typical C Corporation). Owners of a corporation only pay taxes on corporate profits paid to them in the form of salaries, bonuses, and dividends. The corporation pays taxes, at the corporate rate, on any profits.
And the third advantage, which is presented here, is that corporations have a set management structure. Shareholders are the owners of a corporation, who elect a Board of Directors, which then elects the officers. Other than the election of directors, shareholders do not typically participate in the operations of the corporation. The Board of Directors is responsible for the management of and exercising the rights and responsibilities of a corporation. The Board sets corporate policy and the strategy for the corporation. The Board elects officers usually a CEO, vice president, treasurer and secretary, to follow the policies set by the Board and manage the corporation on a day-to-day basis. In a small corporation, the lines between the shareholders, Board of Directors, and officers tend to blur because the same people may be serving in all capacities.
And some of the disadvantages of the corporation are as follows…
The first one is that it costs money to incorporate. At a minimum, there will typically be four types of fees, including: a fee to file the articles of incorporation with the secretary of state; a first year franchise tax prepayment; fees for various governmental filings; and attorney fees.
Next are the formalities… The proper corporate formalities of organizing and running a corporation must be followed in order to receive the benefits of being a corporation.
A huge aspect of the corporate formalities that must be followed consists of paperwork. Reports and tax returns must be compiled and filed in a timely fashion; business bank accounts and records must be maintained and kept separate from personal accounts and assets; records must be kept of corporate actions, including meetings of shareholders and Board of Directors; and licenses must be maintained. It wastes lots of time and nerves and can easily be accepted as a disadvantage.
And the last disadvantage, which is listed here, is the dissolution. Since corporations have a perpetual existence, states provide a mechanism for dissolving a corporation and liquidating its assets. Dissolution does not happen automatically. A corporation can be dissolved voluntarily or involuntarily. A corporation's officers and directors are charged with responsibility for dissolving the corporation, including gathering corporate assets, paying creditors and outstanding claims, and distributing remaining assets to shareholders.
You have already learned the basis of the three types of business. You know their advantages and disadvantages and it is not a problem for you to decide which one is the best for you, right? If you have not decided yet, you have to do it right now. Why to wait? There are great opportunities this year for you to start your business. All you have to do is to choose the best type of business for you. Hopefully, this article has helped you a little to make your choice!
Good luck!