llc partnership pros and cons

When starting a business the entity structure can be a source of confusion. However it’s not a decision to take lightly because the business structure can have an impact on not only your liability risk but also your taxes. If you have more than one owner you have choices.

What is a Partnership?

On a basic level a partnership is a business with at least two owners. A partnership is a pass-through entity which simply means that the profits and losses of the business flow through to the individual partner’s who then include them on their own tax return. An LLC partnership is not really a partnership. It is just a multi-member LLC that elects to be taxed as a partnership. 

It is important to note that an LLC is an entity formed at the state level. It is not recognized by the IRS. This is the reason why LLC owners typically inform the IRS how it is to be taxed. An LLC partnership is similar to a single member LLC in that it provides asset protection for its owners. The major difference is that the partners in an LLC partnership files a Form 1065 while a single member LLC files a Schedule C.

If you have an interest in an LLC that has more than one owner and the LLC you can expect to receive a Schedule K-1 at the end of the partnership’s year. A Schedule K-1, or K-1 for short, is a statement issued to the owners to show their share of the profit or loss in the partnership.

Benefits of a Partnership

  • Ease of Formation
  • Administrative Flexibility 
  • Liability Protection

There are pros and cons of an LLC partnership. It is easy to form because an LLC partnership is not really a partnership. It is just an LLC with more than one member. Unlike a corporation which has to hold meeting minutes no such requirement exists for the partnership.

If your business has several owners and is taxed as an S-Corp, distributions must be made in proportion to the owners’  share of the corporation. In a partnership there is more flexibility. Profits and losses do not have to be apportioned based on ownership percentages. Instead one owner can bear most of the risk or reap more of the rewards.

Downsides of LLC Partnership

  • Increased Compliance
  • Reliance on Others
  • No Tax Savings

A business that is formed as a LLC but taxed as a partnership must file a separate tax return for the partnership each year. This additional tax return adds a level of complexity to tax compliance for the partners. For instance failing to file a partnership return on time could result in a penalty of $210 per month multiplied by the number of partners and that’s just the IRS penalty! States have similar requirements and penalties. An LLC partnership will also need its own tax ID number.

Someone once said that “the only ship that sinks is a partnership!” While we don’t agree with that we can understand the sentiment. When you are in a business with other owners you can’t make decisions on you own. Your actions are generally limited to the approval of other owners. For some people who thrive on independence this could be a drawback.

The S-Corp is popular among business owners because of potential tax savings for its owners. Unfortunately that’s not the case with an LLC partnership. It’s similar to the S-Corp in that it’s a pass-through entity. The income or losses the partnership makes will end up on the owner’s tax return. However, the tax strategies implemented by S-Corp owners are not available to multi-member LLC owners that choose to be taxed as a partnership.

As always it is highly recommended that you consult with a tax professional first before setting up your business structure. Each person’s situation is different so what might be perfect for someone else may not be perfect for you.

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