Any small business owner needs to decide on a legal entity when they incorporate. The decision is a big one because it impacts your structure, legal obligations, taxes, and bottom line. There’s considerable debate over partnership vs. corporation and which one works best. If you’re struggling to decide on the right legal entity for your new venture, here’s what you need to know.
Partnership vs. Corporation
When considering your business structure, you must know the difference between a corporation and a partnership. Not all businesses will suit a partnership, and not all businesses will suit a corporation.
What is a Partnership?
A partnership, simply put, is a business owned and operated by multiple people. Is a partnership a corporation? No, it’s the default business option unless you incorporate it as an entity like an LLC or a corporation. Partnerships are pass-through entities, so there are no business taxes, and each owner files their taxes separately. There are three partnerships to take into account.
- General Partnership (GP)
If you decide on a general partnership vs. corporation, this is the most common partnership. All co-owners are personally liable for the business’s debts and responsibilities.
- Limited Partnership (LP)
An LP has two classes of partners. General partners run the business and take personal responsibility for its debts and responsibilities. Limited partners don’t run the business but invest money. They’re only responsible as far as how much they invest.
- Limited Liability Partnership (LLP)
An LLP is limited to professional service businesses, law firms, accounting firms, and doctors. Partners are not personally responsible for any debts the business occurs. Tax treatment is the same as the other types of partnership.
What is a Corporation?
A corporation is an independent legal entity. You must file incorporation paperwork with your state of residence. Corporations are taxed separately, and the owners are technically shareholders. They also come with no personal liability for the shareholders.
The C-corporation is the traditional type of corporation. It pays the corporate income tax rate on its profits and any dividends paid are reported on the shareholders’ personal tax returns. This corporation can have several stock classes and there are no limits on the number of shareholders.
The S-corporation is a C-corporation that has elected to be taxed like a pass-through entity. All business income and losses are reported through the shareholders’ personal tax returns. Only one class of stock and up to 100 shareholders are possible under an S-corporation setup. Also, only U.S. citizens may be shareholders in an S-corporation.
To summarize, the main difference between a C-corporation and an S-corporation is how they’re treated for tax purposes.
What is the Difference Between a Partnership and a Corporation?
A partnership and corporation can both be ideal setups for a small business. Before deciding between a corporation vs. partnership, you need to know how they differ. It’s an important decision because it’s extraordinarily difficult to alter your business’s structure after incorporation.
Partnerships are pass-through entities, therefore the legal requirements for partners are minimal. Corporations, on the other hand, must file regular paperwork, pay for registration, and cover annual fees. The legal requirements of a corporation are far more stringent and complex.
In a partnership vs. corporation setup, a corporation has a more intricate structure requiring shareholder agreement on key decisions. Remember, a corporation is a separate legal entity owned by the shareholders. Partnerships have a simple structure with no shareholders other than the co-owners.
Starting a partnership requires no more than a Doing Business As (DBA) name and a license. Corporations, on the other hand, require several documents of incorporation, including articles of incorporation, corporate bylaws, and shareholder agreements. For S-corporations, you’ll also need to file IRS Form 2553. The cost of incorporation for a partnership can be just a few dollars, whereas, for corporations, it could cost hundreds of dollars.
Liability and Risk
Asking “how were corporations different from partnerships” boils down to risk. Partnerships put the owners’ personal assets at risk. Corporations are separate legal entities; therefore, the assets of their shareholders cannot be touched. This lack of personal liability is why corporations are so popular.
Taxation and Filing Requirements
As a pass-through entity, owners of a partnership file the business’s income and losses on their personal tax returns. They pay tax at their personal income tax rate. Corporations require a professional accountant to file. Any income made is taxed at the corporate income tax rate. Any dividends and salaries paid to shareholders will be reported as personal taxable income by each shareholder.
In a partnership versus corporation debate, the former is far easier to manage. Corporations have defined management structures and must elect a board of directors. The latter can also issue additional stock, and shareholders may buy out other shareholders, which could impact the board of directors and impact the management of the business.
When you’ve decided on a partnership vs. corporation, you need funding to get your venture off the ground. Get in touch with L3 Funding to learn more about your various funding options. We’ll work with you to get you the secure finance you need. Start your business and apply for funding today.