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Abstract – U.S. corporations and partnerships share many features in terms of protecting yourself and your investments. Deciding which form of business entity to choose, or when to change, is a complex and ultimately personal decision. However, there are guidelines that can frame the argument before you sit down with your lawyer and accountant.
There are so many forms of business entities that forming the right one for you and your business is a full time job in itself. Two forms that are very similar and easily confused are the Limited Liability Company and the Limited Partnership.
The Limited Liability Company (LLC) is a relatively new form of business organization and its structure can vary greatly from state to state. An LLC has characteristics of a corporation but is technically an unincorporated association. Members may include individuals, corporations or even other LLCs. Some types of business cannot be LLCs, like banks, and the IRS does not a tax classification called LLC so you will have to file taxes as a corporation, a partnership, or a sole proprietor. The good thing about this is that it allows business owners to pay taxes on their individual income but provides more protection from lawsuits and debts like a more traditional corporation.
A Limited Partnership (LP) can consist of two or more persons. Though you must file financial information, the partnership itself cannot pay taxes. Profits and losses are the responsibility of the owners in the same percentage as their ownership. One or more partners must be designated as “general partners” who have unlimited liability. Other partners are not legally responsible for debts greater than their percentage of contribution, but also cannot take part in running the business. Note that a LP has different characteristics from a Limited Liability Partnership (LLP) and the still very rare Limited Liability Limited Partnership (LLLP).
Behind those simple definitions are many thorny legal and tax questions that require the input of professionals familiar with your finances and local government. Before you decide if one of these is the best form for your business, here is a quick overview of some advantages and disadvantages. This should be the starting point of your research. Take your time in working through the answers and then bring this with you to consult your legal and tax help.
What are the advantages of an LLC over an LP? The main reason anyone incorporates is to protect your assets from creditors and taxes. Advantages include:
Owners can participate in managing the company but can act as a board of directors if you prefer
Creating your own operating agreement forces you to think through how the company will work on a daily basis and save you from operating according to default state laws.
There does not have to be a designated owners who must accept legal or financial obligations above their percentage of ownership
You can make separate ownership and profit percentages. You could retain 10% ownership but 20% of the profits based on the benefit you provide to the company--as long as your other members agree to that.
What are the advantages of the LP over an LLC?
Partnerships are popular for the low cost of operations. There are normally lower filing fees, they begin the moment the partners begin doing business, and there are fewer ongoing operational requirements.
They are just as quick to dissolve. This makes them ideal for short term projects like artistic productions. The death, withdrawal, or bankruptcy of the general partner ends the partnership.
LP’s are designed for an entrepreneur who wants to gain investors while retaining managerial control. For the limited partners, limiting the financial obligations comes at the cost of excluding them from participating in the operation of the business.
Remember that laws vary greatly depending on where the LLC or LP was formed and where it conducts the majority of its business. As you gather information on legal and tax requirements, you must also take time to assess how important it is for you to have effective control over your business. Would you rather trust experts or trust your gut instincts? It has helped other business owners to convert value judgment decisions like these into dollar values. How much is responsibility and control worth to you?
Photo courtesy of josstyk via Flickr