Just what IS a limited liability company? Part 2. It’s not a partnership.

[This is the second post in a seven-part series discussing the characteristics of limited liability companies and comparing them to the characteristics of corporations, general partnerships, and sole proprietorships. Here’s the entire list.

Part 1. Background on sole proprietorships.
Part 2. Background on partnerships.
Part 3. Background on corporations.
Part 4. LLCs are distinct legal entities, separate from their owners.
Part 5. A limited liability company’s owners are not liable for the LLC’s obligations.
Part 6. Options for an LLC’s management structure.
Part 7. Options for an LLC’s tax treatment.]

iStock_000000489267XSmall.jpgIn the last entry, I began a discussion of the basics of limited liability companies. To start that discussion, I began by describing the first of three other types of business structures: sole proprietorships. This entry is about partnerships, and the next will describe corporations.

In a sense, a general partnership is like a sole proprietorship, but with multiple proprietors. Each partner is liable for all of the obligations of the partnership. In other words, a creditor of the partnership can sue any or all of the partners to collect what the partnership owes. Income taxes are also similar, but things get a little more complicated with multiple owners.

For tax purposes, a general partnership is a “pass-through entity.” Unlike a sole proprietorship, a partnership has to file a tax return, called Form 1065. However, the partnership itself does not have to pay taxes. Form 1065 is used to calculate the partnership’s profits or losses and other “tax items,” which are allocated to the partners, most often in proportion to their ownership interests. In other words, the tax items are “passed through” to the partners, and each partner receives a report from the partnership called a Schedule K-1 that tells the partner how much income, etc. to report on his or her own personal tax return. Then the partner pays income tax as an individual.

One more point worth noting about taxes. If the partner is actively involved in the operation of the partnership — in essence, if the partner is “employed” by the partnership — he or she is considered to be self-employed and must pay self-employment tax on his or her share of the partnership’s income. Again, being a partner is very much like being a sole proprietor, except for the “sole” part.

The general partnership is an old form of business association. For instance, in Dickens‘s A Christmas Carol, Ebenezer Scrooge and Jacob Marley were partners. “The firm was known as Scrooge and Marley. Sometimes people new to the business called Scrooge Scrooge, and sometimes Marley, but he answered to both names. It was all the same to him.” Id. at p. 3. Of course, I’m not holding out Scrooge and Marley as a typical partnership or as a model of customer service. The example came to mind only because last month our family attended the Indiana Repertory Theater‘s annual production of A Christmas Carol, and I’ve always liked that line.

In the next entry, I’ll describe corporations, and then (finally!) get around to discussing limited liability companies.

If you’d like to discuss the options for starting up a new business, please feel free to contact our office for an initial consultation.