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If you’re considering establishing a business, you must consider what legal entity will you establish? You might already be familiar with limited liability companies (LLCs), but that’s not your only option. Let’s look at two of your other choices: partnership vs. corporation.
- A corporation is a separate legal entity that issues shares (stake in the company) to owners and protects their personal liability
- A partnership is owned by its partners and is easier to establish and maintain
- Partnerships and some corporation types are pass-through entities, which means they avoid double taxation
- The right entity type depends on your unique business
What is a partnership?
Partnerships require two or more people. When they form the partnership as general partners, they agree to share the company’s ownership, profits, liabilities and operations.
It’s best practice to create a partnership agreement when establishing this legal entity. That document should break down ownership share by percentage across partners and each partner’s responsibilities at the company.
Partnerships can take three different forms:
|General partnerships||The basic and most common type. General partners have full decision-making authority and unlimited liability (full responsibility for debts)|
|Limited partnerships (LPs)||Limited partners get involved purely by investing money — those limited partners have limited personal liability|
|Limited liability partnerships (LLPs)||Reserved for certain business types (such as medical practices or law firms) and protect partners’ personal assets|
All partnerships function as pass-through entities in the eyes of the IRS. That means they’re not subject to corporate tax. Instead, partners report the company’s profits and losses on their personal tax returns and pay any taxes owed from their own pockets.
What is a corporation?
When you create a corporation, you establish a separate legal entity. This protects your personal assets.
Unlike a partnership, in which ownership and daily operation responsibilities are shared among general partners, shareholders own corporations. All corporations issue shares (also called stock), and the number of shares an individual owns dictates their ownership stake in the company.
Corporations are complicated to establish and maintain. For example, they’re legally required to hold regular board and shareholder meetings and to submit annual reports on their business activities.
Corporations can take several forms. Two of the most common are:
|C corporation||The traditional structure in which the number of shareholders and class of stock aren’t limited and both the corporation and the shareholders pay taxes|
|S corporation||Capped at 100 shareholders and one class of stock but allow the corporation to pass tax liability on to the shareholders, avoiding double taxation|
Differences between partnership and corporation
There are several differences between partnerships and corporations. Key differences include:
- Corporations establish a separate legal entity, limiting owners’ personal liability, while partnerships mean owners personally represent the business
- Partnerships are pass-through entities so they don’t pay corporate taxes; some types of corporations (namely, C-corps) are subject to the corporate tax rate
- Corporations can issue shares to individuals, making them owners in the company, while partnerships need to add new partnership to share ownership stake
- Partnerships are easier to set up and maintain
Compare differences between partnership and corporation
To help you better weigh the partnership vs. corporation situation, let’s look at those differences in detail.
|Partnership||C Corporation||S corporation|
|Formation||Business license (and possible a “doing business as” (DBA), depending on your state), partnership agreement not required but recommended||Articles of incorporation, corporate bylaws, shareholder agreement and stock certificates||Articles of incorporation, S-corporation election, corporate bylaws, shareholder agreement and stock certificates|
|Ownership||Two+ people||1 to 100 people||1+ people|
|Taxes||Paid for on personal income tax returns||Paid for on both corporate tax returns and personal tax returns (for shareholder’s dividends from the company)||Paid for on personal income tax returns|
|Liability||Personal liability for general partners; limited liability for limited partners in an LP and partners in an LLP||No personal liability||No personal liability|
|Requirements and maintenance||Varies by state, but generally, an annual fee/tax||Annual reporting, regular board and shareholder meetings and record maintenance||Annual reporting, regular board and shareholder meetings and record maintenance|
Forming a partnership is much easier and cheaper than forming a corporation. Usually, you just need to secure a business license and, in many states, file a “doing business as” (DBA). You’re not even legally required to have a partnership agreement that dictates how your company breaks down between partners (although it’s recommend establishing this key document as you found your company).
To form a corporation, you start by filing Articles of Incorporation and getting any business licenses and permits required by your state and municipality. You need to establish company bylaws, establish a shareholder agreement, issue shares and have your shareholders elect a board. To operate as an S-corp, you must also file that election (IRS Form 2553).
In a partnership, the company is owned by the general partners and, if applicable, limited partners. General partners make the call on how the daily operations run.
In a corporation, the company is owned by its shareholders. They don’t get involved in the business’s decision-making, though. Instead, the shareholders elect a board to steer the company. The board then appoints officers (such as a CEO and CFO) to manage different parts of the company’s operation.
Both partnerships and S-corporations are pass-through entities. That means the company can pass tax liability through to its owners, who report and pay anything owed to their IRS through their personal tax returns.
C-corporations are subject to the 21 percent corporate tax rate on profits. Their shareholders are also subject to personal income taxes on any dividends they receive. You might hear this called double taxation. That said, operating as a C-corp can offer you some flexibility. For example, you might be able to claim certain corporate tax deductions and credits or move money around to different taxable years.
Unless your business type is eligible for an LLP, functioning as a general partner means putting your personal assets at risk.
A corporation, on the other hand, gives you liability protection. Because the corporation operates as its own legal entity, it separates the company and its owners. You can’t be held personally liable for debts, legal fees, etc. Only your business assets are on the line.
Requirements and maintenance
Maintaining a partnership is pretty simple. In most states, it means paying an annual fee or tax to maintain your structure.
A corporation, on the other hand, requires quite a bit of work to be legally compliant. You need to hold both board and shareholder meetings regularly. Those meetings need to be carefully documented with official minutes. You’re subject to other requirements for recording and reporting business activity and must have and abide by company bylaws. Ultimately, this can all make running a corporation much more energy-intensive and expensive than running a partnership.
How to choose between partnership and corporation
If you’re still weighing partnership vs. corporation for your burgeoning businesses, there are a few key factors to weigh:
Partnerships and S-corporations have the advantage of being pass-through entities. That means the company doesn’t pay taxes. Instead, income, losses, deductions and credits get passed through to the partners (in a partnership) or shareholders (in an S-corp). They pay taxes on their personal tax returns based on how the company performs.
While a C-corporation means paying the corporate tax rate (21 percent in 2023), it can also lead to tax savings. C-corporations have more options for deductions and other tax perks than other legal entity types.
A certified public accountant (CPA) can help you evaluate your options based on your unique business to determine if one entity type would deliver notable tax advantages.
If you plan to seek out investors, a corporation likely best suits your needs. While a limited partnership can allow you to bring on investors without involving them in daily operations, many investors specifically want stock. Many venture capital firms and angel investors will only invest in a company if they can get issued shares. And that means you’ll need to operate as a corporation, the only legal entity type that can issue stock.
Consider legal risk
Unless you plan to operate in an industry that makes you eligible to form an LLP or only get involved as an investor in an LP, joining a partnership means putting your personal assets at risk. If the business can’t cover its debts, its creditor can seek recourse from you.
A corporation, on the other hand, eliminates your personal liability.
In the partnership vs. corporation debate, many arguments can be made for both options. Ultimately, it comes down to your unique business. How will it operate? Will you need to fundraise by selling stock? Are you okay with your personal assets being exposed?
While it’s not easy, you can change your entity structure. If you’re unsure where to start, the ease and affordability of a partnership might be the best path forward for now.
Frequently asked questions
That depends entirely on what your business does, how many people want to get involved in running it, if you plan to fundraise and your appetite for risk in the form of personal liability. Weigh key factors to consider which legal entity type may best serve your company.
If you want to be able to issue stock, a corporation gives you that option. If you’re worried about risking your personal assets, though, a limited liability company (LLC) might better serve you.
An LLC means creating a separate legal entity, while a partnership attaches legal responsibility to the individual partners. That means an LLC protects your personal assets, but partnerships are generally easier and cheaper to establish and maintain.