What is the Difference Between Incorporation, LLC and a Partnership?

Q: What is the Advantage, if any, of Incorporating vs. a Partnership?

A: In fact there are advantages to either one but depending on your situation that you may be in you can be either one as well. In addition, there are two types of partnerships: a limited partnership and a general partnership.  Also, there are an "S" Corporation and a "C" Corporation as well as a partnership LLC and or Corporation LLC.  Though there are a lot more considerations, here is a list that you can go by but ultimately you need to talk to a CPA and or Attorney for exact information tailored to your specific business reality: 

Partnership Disadvantages:

• The first one should be that in addition to other business registrations, you will need to execute a partnership agreement.  Then, you will need to change that agreement each time duties and rights of the partners change.  To understand that, compare to a corporation that once the bylaws are executed, there is little change subsequently, if any is required.
• When I was in law school, my Harvard Professor said that if God thought that a partnership or corporation was better than a sole proprietorship to save the world, He would not send Jesus Christ alone but He would send a group of people as a partnership or better yet a corporation.   Obviously, operating alone results in faster decisions because many partners' different goals and opinions may result in serious disagreements.  For example, a partner may want to go global another one he may not.

Partnership Advantages:

• Perhaps the most important advantage of a partnership is that it does not pay business income tax as such, namely, as a partnership.  What happens is each partner receives his percentage of the income and in turn pays the IRS.  To do that, partners must file an (IRS Form 1065) in which they can claim their income and loss as a pass/thru entity.
• The getting together of people in business in most cases results in a beneficial relationship because each one brings his own experience to the table.
• In addition, as opposed to a sole proprietorship that the owner is solely liable for business debts, in a partnership all partners are liable.
• Each partner will bring in some money as well.  If it is a loan, it will create interest income for the partners and the partnership may deduct that.

"C" or "S" Corporation Advantages:

• Surely, the most important advantage of a corporation is that the shareholders / owners are shielded from personal limited liability as far as business transactions of the corporation are concerned because a corporation is a separate legal entity from the owners / shareholders .   So for example, Jane and Tarzan decide to form a corporation, "Jungle Beast,"  to sell coconuts to the Europeans.  They form a corporation but a European buyer that does not receive his coconuts sues the corporation for lost profits.  Tarzan and Jane, because they are shareholders of the corporation, are not liable to pay any damages.  European buyer can only sue for whatever assets the corporation has.  As a result, Tarzan's expensive African artifacts bought from an African village are not in danger of been foreclosed to satisfy the lost profits judgment.  Nor is, Mumbo, Jane's pet elephant, or her hut subject to foreclosure.
• Having a corporation may lower your taxes because you could split the corporate profits among shareholders to lower tax bracket and thus the liability of shareholder tax.  This is because there is something called double taxation: a corporation is taxed and then the shareholders are taxed. However, if the shareholders take all profit as income or dividends, the corporation remains with no profit and thus is not taxed.
• Getting business financing may be easier for a corporation because banks favor big businesses that are corporate entities.  However, this may not be true for new businesses and shareholder may still have to offer a personal guarantee to get a business loan for the corporation.
• Another advantage is perpetual existence.  That is, even if one partner shareholder dies, the corporation continues.  His share of stock goes to those that are legally allowed to inherit it.
• In addition, perhaps a very powerful benefit is the 100% percent medical insurance and medical expenses you can get (and deduct  it from the corporate income to bring it to a lower bracket ) from having a "C" corporation.  That is true as well for disability and life insurance benefits.  The downside to it is that you may have to be an employee of the corporation and if you have other employees, you need to provide the same coverage for them as well which nullifies some of the benefits gained.

Corporation Disadvantages:

•  The most important one for small businesses is that business losses incurred by individual shareholders are not deductible by the corporation because a "C" corporation is completely a separate business legal entity than its owners.  For instance, if Bob Jones, a shareholder loses $100,000 in a personal business not related to the corporation, he cannot deduct it from the corporation profits or income while he can do that with a partnership.

• Another disadvantage is that if the corporation makes more than $70,000 to $80,000 and above, the tax rate is higher than that of  a partnership or sole owner.  The tax rate for accumulated earnings tax on profits in excess to $300,000 is close to 30% or a little less.

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Where can I get the forms?

- You can download the form from this website. You can also call us and we will mail, fax or email you the forms. Forms are also available at our office.

If I have questions, who should I contact?
- We want to hear from you. Contact Partnerships or Corporation Division at (310) 455-6675, ext 000.

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