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Partnership vs. Corporation: What’s the Difference?

partnership vs. corporation

The structure of your business determines many of your responsibilities as a business owner, such as what taxes you pay and your level of personal liability.

Of the available business structures, also called entities, a partnership and a corporation are common options. Both can be operated by more than one person, but there are differences in how you must manage each type of business.

While you may be able to change business structures throughout the life of your company, it could be a difficult process. To help you choose the right structure for your business, we’ll help you understand the details of a partnership and a corporation.

What is a partnership?

A partnership is a business with two or more owners who each contribute money, property, labor or skills to the operation. The IRS considers a partnership a pass-through business, meaning all partners share the profits and losses of the business and add their portion to their personal income.

Partners must pay personal income taxes on their share of the business. Partners may also be responsible for self-employment taxes and estimated taxes, while the business itself may owe employment taxes and industry-specific excise taxes.

There are three types of partnerships that allow you to adjust the amount of liability for business owners.

General partnership

When you establish a partnership, you’re likely forming a general partnership, which occurs when two people work together to earn a profit. You may not have to officially file with a government agency when you form a general partnership, depending on the state in which you live.

A general partnership does not provide any personal liability protection. You and your partner would bear the responsibility for the business’s debts, and your personal assets would be at risk if the business were sued.

Although a general partnership doesn’t offer legal protection, it requires less paperwork and simpler tax filing than other entities. It may be a good structure for small businesses just starting out.

Limited partnership

A limited partnership offers some protection for partners. While one general partner must assume personal liability, the other partners, called limited partners, would be protected from personal liability.

Limited partnerships must be formed through a state government agency. This structure would be best for a business with one partner who is active in daily operations and could take on liability, as well as one or more less-active partners who contribute to the business but would not want to be fully liable. Limited partners cannot be involved in day-to-day business functions.

Limited liability partnership

A limited liability partnership provides liability protection for all partners. Although regulation of limited liability partnerships varies at the state level, the structure allows all partners to shield their personal assets. Partners also would not be responsible for the actions of other partners within the business.

What is a corporation?

A corporation is a legal entity that is separate from its owners. A corporation can act independently and make a profit, be taxed and be held legally liable. This business structure offers business owners full protection from personal liability.

A corporation is held to a higher standard of record-keeping than other business entities. Corporation owners must file annual reports, hold annual shareholder meetings, elect a board of directors to oversee the business and follow company bylaws. Because of these extra responsibilities, a corporation can be an expensive business to run.

There are several types of corporations from which you could choose, but the two common options are C corporations and S corporations. Here’s how they differ:

C corporation

A group of business owners called shareholders must file articles of incorporation with their secretary of state office to form a C-corp. Shareholders have limited liability and are not responsible for the company’s debt. They can also sell shares of company stock. If you plan to take your company public, it must be classified as a C-corp.

There’s no limit to how many shareholders a C-corp can have. If an owner decides to leave the company or sell their shares, the company would mostly be unaffected and could continue operating.

The IRS requires C-corps to pay corporate tax. A C-corp is subject to double taxation because the company has to pay corporate taxes, while shareholders must pay taxes on the dividends they receive on their personal tax returns.

S corporation

To form an S-corp, shareholders would have to file articles of incorporation with the secretary of state. Like a C-corp, an S-corp provides limited liability for owners, meaning they are not responsible for the company’s debts. But an S-corp cannot have more than 100 shareholders, and all shareholders must be U.S. citizens.

An S-corp is considered a pass-through entity, like a partnership, and does not pay corporate taxes. The company’s profit and losses are passed through to shareholders’ individual income taxes, and their portion is taxed at the personal income tax rate. Some states impose a second tax on S-corps, so you may not be able to completely avoid double taxation.

Partnership vs. corporation: The differences

When choosing to establish a partnership vs. a corporation, consider these differences between the two entities.

Varying degrees of personal separation from the business

Both S-corp and C-corp structures give business owners limited liability. All shareholders involved with the business could avoid putting their assets at risk or being personally liable for the company’s debts.

A partnership could provide the same protection if you opt to form a limited liability partnership. If not, either all or some of the business partners will have to remain personally liable. A general partnership does not provide any legal protection, while a limited partnership would protect the assets of a few of the partners.

Corporations owe corporate taxes

Partnerships and S-corps are classified as pass-through businesses and do not pay corporate taxes. Instead, both entities require personal taxes and possibly self-employment taxes from business owners.

C-corps must pay corporate taxes when the company makes a profit. C-corps are then taxed again when paying dividends to shareholders.

Partnerships require 2 or more owners

To be considered a partnership, the business needs at least two owners. Both S-corps and C-corps can have just one owner. A C-corp can have an unlimited number of owners while an S-corp can have no more than 100 shareholders.

Here’s a quick look at how the details compare:

Partnership S Corporation C Corporation
Ownership 2 or more people 1 or more people, but no more than 100 shareholders 1 or more people; unlimited number of shareholders
Taxes Personal taxes Personal taxes Corporate taxes (company) and personal taxes (shareholders)
Liability Unlimited personal liability, except for limited liability partnerships No personal liability No personal liability

How to choose the right business structure

When deciding between a partnership or a corporate structure, consider the level of personal liability with which you’re comfortable. One of the biggest differences between the two structures is the amount of legal protection that’s provided.

A corporation would offer the highest level of protection, as all owners would have limited liability. In a partnership, at least one owner would typically have unlimited liability. But you could obtain full protection if you set up a limited partnership.

Your goals and plans for the business should also impact the entity you choose. If you hope to one day take the company public, you should establish your business as a C-corp. A C-corp is the only type of business that can raise funds through the sale of stock in the company.

A corporate designation would also be best for high-risk businesses. But a corporation can be expensive to run because of the required maintenance. For instance, you may need to hire an accountant to manage your finances or a lawyer to write the company’s bylaws.

It’s possible to change your business structure at a later time. If you’re just getting started and want to test your concept, consider first establishing a partnership before choosing a more formal entity like a corporation. A partnership is less complex than other structures.

Whichever business entity you choose, you may want to work with a business advisor, attorney or accountant to make sure your paperwork is in order and that you’re making the right choice for your small business.

 

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