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The beginning framework of a new business can fundamentally impact the tax obligations, regulations, and liabilities you face. It’s wise to know the difference between the types of business entities and which best suits your organization now and in the future. To optimize your finances, you need to understand what a partnership is vs. a corporation. Let’s look at the differences and similarities between corporations and partnerships

What is a Partnership?

According to the IRS, “A partnership is the relationship between two or more people to do trade or business. Each person contributes money, property, labor or skill, and shares in the profits and losses of the business.”

A partnership may form when two individuals decide to open a business together. The IRS considers you a “disregarded entity” as a married couple unless you register as a partnership, LLP, or LLC (with or without an S-corp election). Because you are married, the federal government considers you one entity together. 

There are no formal legal agreements necessary for opening a business and working as a partnership. However, without a formal structure, there is also more risk of liability on the part of each partner. 

General Partnership

Without a formal structure, a partnership business entity is called a “general partnership.” You and your partner work together to run the business however you decide together. You may need to file assumed name certificates or trademark registrations, but no governmental filings are necessary except filing taxes. 

If you want a different name than your own names, you can download the Certificate of Assumed Name. An assumed name is filed with the County Register of Deeds.

Liability: Both partners are wholly personally liable.

Taxes: Profits pass through to the partners, who pay personal income tax on their share. 

Limited Partnership

With a Limited Partnership, any person or entity may come together as general partners. Limited partnerships often consist of limited partners who exert less control and have less liability than the general partners. For a limited partnership business structure, you need to file a certificate of limited partnership. 

Liability: General partners are wholly liable, limited partners may have limited liability.

Taxes: Profits pass through to the partners, who pay personal income tax on their share. 

Limited Liability Partnership

For a limited liability partnership, you need to register with the secretary of state as an LLP.  Other than the registration with the Secretary of State, these two business structures are very similar and operate according to similar liability and taxation. 

“With an LLP, whoever is in charge is legally exposed in the same way owners of a simple partnership are exposed. Silent partners and investors in an LLP receive liability protection as long as they do not take on a managerial role. If they do, a court could pierce the veil of liability protection.” (3)

LLP Liability: A general partner accepts personal liability for the LLP’s business dealings. Each limited partner’s liability for another’s malpractice is limited to their investment in the company. However, if the partnership as an entity faces a liability beyond its financial capabilities, creditors cannot legally sue for personal assets or income from partners. 

LLP Taxes: LLP profits pass through to the partners, who pay personal income tax on their share. 

“Both LLCs and LLPs have similar abilities to limit the liability of each partner or member involved in the business. However, there are also some differences between the two entities. LLPs must have a managing partner who can bear the liability for the LLP’s actions.” (4)

S Corporation (Taking the Federal S-Election)

A domestic entity that has more than one member will default to a partnership for (federal) taxation purposes. An LLC with multiple owners can either accept its default classification as a partnership or file Form 8832 to become taxable as a corporation. (5)

If you file an S election with the federal government, you become an S-corporation for federal tax purposes.  

A corporation or other entity may elect to be an S corporation only if it has:

  • No more than 100 shareholders who are individuals, estates, exempt organizations, or certain trusts; 
  • No nonresident alien shareholders; 
  • Only one class of stock. Outstanding shares of the corporation’s stock confer identical rights to distribution and liquidation proceeds;
  • Is not certain types of banks, thrift institutions, insurance companies, or domestic international sales entities; and
  • A tax year listed (or adopts a tax year listed) on the S-election IRS Form 8832.

There are several advantages to establishing a North Carolina S corporation. With an S-corp structure, stock ownership changes are also more easily made, and if a stockholder dies, there is a plan for the corporation’s continued success. 

Liability: Personal liability does not change because an LLC, LLP, or Corporation takes an S-election.

Taxes: A primary reason for changing your business structure to an S-Corporation is that you, as a Corporation, no longer pay federal income tax. Unlike with a corporate structure, all of the income and losses of the S-corp pass through to the stockholders. An S-corp is often called a Pass-through Entity for that reason. An LLC, LLP, or partnership may also benefit from an S-election as it can reduce the employment taxes paid by members or partners. 

C Corporation

Sometimes, a business starts with general partners, but then they decide to incorporate. Incorporation as a C-corp has many steps. To begin, as a C-Corp, you must file Articles of Incorporation, decide classes of stock and initial shareholders, and elect a Board of Directors. 

Unlike a simple partnership, a C-corp must also file an Annual Report to the Secretary of State. 

Liability: Personal liability of stockholders is limited. 

Taxes: Income of the C-corp is taxed to the corporation while dividends are taxed to shareholders. 

However, if you start as a C-corp, you can still take the S-election to become an S-corp. This S-election changes your federal tax status to a pass-through entity. 

Asking the Right Questions

Starting a business demands consideration of how your structure will function. 

  • How much personal liability are you comfortable with?  
  • How will you receive compensation? 
  • Do you need a pass-through entity to get the best outcome for your federal taxes? 
  • What are your federal and state obligations for your entity structure?

We Can Help

At Hill Law, we help you find the answers you need to make these tough decisions. Your practices affect your bottom line, and we understand how to optimize your structure from the beginning. We are also ready to change directions if you need to grow into a different type of structure. Contact us and find out how we can help your business start well and thrive in the future. 

 

Footnotes:

 

  1. ASSUMED BUSINESS NAME CERTIFICATE (NCGS §66-71.5)
  2. Find Your Register of Deeds – North Carolina Association of Registers of Deeds
  3. Limited Liability Partnership Vs. Limited Liability Company
  4. Difference Between LLP and LLC: Everything You Need to Know 
  5. LLC Filing as a Corporation or Partnership | Internal Revenue Service 
  6. About Form 8832, Entity Classification Election | Internal Revenue Service