What is a Partnership?

A partnership is a form of business where two or more people share ownership, as well as the responsibility for managing the company and the income or losses the business generates. That income is allocated to partners, who then claim it on their personal tax returns. By contrast to C Corporations, the partnership is not taxed separately, on its profits or losses.

Partnership Types

There are three types of partnerships:

  • General partnership
  • Limited partnership
  • Joint venture

General Partnerships

In a general partnership, each partner shares equally in the workload, liability, and profits generated and paid out to the partners. All partners are actively involved in the business’s operations. All partners have personal liability for partnership debts and obligations, including personal injuries caused by the partnership, as well as partnership unpaid payroll, payroll taxes, and sales taxes.

Limited Partnerships

Limited partnerships are partnerships with what are called limited partners. A limited partnership must have at lease one General Partner. While the limited partners generally have protection from personal liability for partnership debts, in most cases (but watch out for payroll tax debts), the general partners have unlimited liability for partnership debts.

Limited partnerships  allow investors to buy into a business but maintain limited liability and involvement. Their ownership is generally based on their contributions to the limited partnership. This is a more complicated form of partnership. The General Partners have decision-making authority.

Joint Ventures

Short-term projects or alliances that bring together multiple partners for a project are typically structured as joint ventures. If the venture performs well, it can be continued as a general partnership. Otherwise, it can be ended.


There are several advantages of choosing to structure a business as a partnership, which include:

  • Somewhat easier to set up and maintain over time
  • Partners can pool their resources to fund the company’s start-up
  • Partners can share the workload and the rewards of the business’s success
  • Being able to offer key employees the potential to one day become a partner in the business can be a big carrot that encourages them to stay long-term


As you can imagine, where there are advantages, there are also disadvantages to forming a partnership:

  • Where more than one owner exists, there are bound to be differences of opinion that could threaten the business
  • Although partners split any profits the business generates, if the payout is not in sync with each partner’s contribution to the company, disagreements can erupt
  • Unlike corporations, which help to shield owners from liability, the general partners of partnerships have both joint and individual liability. That is, all general partners are liable for their own actions on behalf of the company as well as the actions of the other partners.


There are no annual taxes to be paid, but the partnership does need to file a federal and California income tax return, and then  issue a K-1 form to all partners to be included in their personal income tax filings. Further if the partnership has employees it will be required to file payroll tax returns like any business with employees, and if it collects sales tax it must also file sales tax returns.


The takeaway here? Be very cautious  who you go into business with, because you could be liable for their actions as they relate to the business. And getting out may not be easy should decide that you do not want to be partners any longer.

LLC vs. Partnership

Organizing your small business as a limited liability company or as a partnership affects three key areas:

  • taxation,
  • operation, and
  • owner liability.

If your business has two or more owners, assuming you do not want to form a corporation instead, you can structure it as a limited liability company (LLC) or a partnership. The two options have similarities but also a number of differences in the way they’re run, the way they’re taxed, and the type of liability protection that owners receive.

Below are LLC and partnership features, advantages, and disadvantages.

LLC vs. Partnership: Liability for Business Debts

Persons who start a business together are deemed automatically have a general partnership unless other steps are taken.

A general partnership is relatively simple to set up and maintain. However be warned, the partners are each fully liable if a creditor obtains a judgment or owes other debts. For this reason alone, except in unique circumstances, I generally do not advise the use of general partnerships.

As an alternative, the parties can set up a formal business entity such as an LLC, limited partnership, or limited liability partnership (for certain California professionals in qualifying professions).

In each of these business types, generally the owners have limited personal liability. Business creditors can go after company assets, but the owners’ personal homes, bank accounts, investment properties and other assets are safe.


An LLC is not a partnership for California non tax law purposes, though many LLC owners casually refer to their co-owners as “business partners.”

All LLC owners—known formally as “members”—are protected from personal liability for business debts of the LLC unless they personally guaranty the debt or they are the or a cause of injury to someone.For example, while driving the company vehicle one of the members injures a third party. The member will have personal liability for causing that injury, and the LLC for whom the member was driving on company business or in a car owned by the LLC, will also be liable. Make certain the LLC carries a lot of insurance, and names the owners as additional insureds.

Limited liability partnership.

California allows limited liability partnerships. Different states have different rules for such partnerships. Most allow limited liability for some or all of the partners, but some states hold partners liable for business debts or require at least one partner to be fully liable. And some states limit LLPs to certain professions.

Limited partnership

A limited partnership has at least one general partner and at least one limited partner. The general partners run the company and remain fully liable for business debts. The limited partners are passive investors who cannot be involved in decision-making and aren’t liable for company debts. Limited partnerships are mainly used in commercial real estate and other industries that need to raise money from a group of passive investors. Limited partnerships are also used in California instead of LLCs where the owners expect to have large gross receipts for the business each year and wish to avoid the California LLC gross receipts tax.

The Tax Differences Between an LLC and a Partnership

Interestingly, a multi member LLC is taxed as a partnership for  income tax purposes, as a default, because the the tax code automatically classifies both LLCs and partnerships as  pass through entities.  This means that owners report their share of company profits and losses on their personal tax returns.

However, an LLC does have advantages over a partnership in that an LLC can also elect to be taxed as a corporation. Some LLC owners find that they can save money on taxes and boost their retirement savings by electing S corporation status. However, not all LLCs qualify to be taxed as S corporations.

Taxation is a complex and ever-changing topic. Consult us to see whether you could see a tax benefit by organizing your business as an LLC as opposed to a partnership.

Organizing and Running LLCs vs. Partnerships

Both LLCs and limited partnerships are created by filing forms with the state of California. General Partnerships do not have any required California state filings.

There are some differences in the way the two types of businesses are conducted.

An LLC doesn’t require a general partner. Instead, it can be managed by its members or by a group of managers, with the other members acting as passive investors. The LLC operates according to its operating agreement, a document that includes such things as how profits and losses are distributed, capital contributions of each member, how decisions are made, and the procedure for adding new members or dealing with departing ones.

An LP operates similarly to an LLC, except that the governing document is a partnership agreement rather than an operating agreement. All general partners can participate in running the company. Generally, limited partners cannot. However, a limited partner who is also officer of a corporate general partner can participate in managing the LP business without losing his status as a limited partner.

In general, an LLC offers better liability protection because it does not require a general partner with exposure to unlimited liability. An LLC that makes an S Corporation election for tax purposes can avoid or minimize payroll taxes on the owners’ income. Other than that, the income tax aspects of the two are equivalent.

LLC or LP: What’s Best for Your Business?

Understanding the relative benefits and limitations of an LLC and an LP is important when determining which type of entity would be best suited for your company.


Limited liability companies (LLCs) and limited partnerships (LPs) are two of the most popular business entities. If there are two or more owners and the parties have decided they do not want to use a Corporation, then they can choose between these two business formation options.

Factors in making a choice

Following are some of the factors you need to evaluate when deciding whether an LLC or an LP would work best for your business.

When an LLC is the better choice

In general, an LLC might be better if one or more of the following apply:

  • You want all owners to have limitation of liability for company debts
  • All owners will participate in managing the company
  • You want the option of electing to be taxed as a corporation such as a S Corporation

When an LP is the better choice

An LP might be better if any of the following apply:

  • You want passive investors who you do not want to participate in management decisions
  • You already have an LLC that will serve as the general partner
  • You are not particularly concerned about the personal liability of the general partner
  • You want to avoid the California LLC gross receipts tax

Taxation Differences

The Internal Revenue Service (IRS) treats both LLCs and LPs the same for tax purposes upon formation. that is, formation is generally tax free, with some exceptions.

However, operationally, an LLC has the option of electing to be taxed as if it were a corporation. Limited partnership tax treatment doesn’t allow for such an election.

If partnership taxation is desired, there is no tax advantage to either type of entity. But if you want your company taxed as a corporation, you will need to organize the company as an LLC and then file the necessary IRS forms  to elect corporate taxation treatment.

Dont’ forget state taxes. California imposes a LLC gross receipts tax unless the LLC elects to be taxed as an Corporation. California also imposes a state 1.5% income tax on S Corporation net income.

Organizational Differences

There are differences in how LLCs and LPs are structured and created.

Note: a member of an LLC, as well as a partner in an LP, may be an individual person, a corporation, another LLC, or another partnership.

LLC structure.

A person who has an ownership interest in an LLC is called a member. An LLC with two or more members is called a multiple-member LLC. Forming an LLC requires filing  Articles of Organization, with the California secretary of state.

Many LLCs also have an Operating Agreement, which set forth the members’ ownership interests, rights, and responsibilities.

LP structure.

A person with an ownership interest in an LP is called a partner. In an LP, there are two types of partners: general partners and limited partners. There can be one or more general partners and one or more limited partners. Both own a certain percentage of the company, but only general partners can engage in operating the business. Limited partners are passive investors who share in profits and losses but have no say in how the business is run. Having passive investors is the main advantage of a limited partnership. Forming an LP is typically done by creating a Partnership Agreement, which spells out the ownership interests, rights, and responsibilities of the general and limited partners. As with an LLC, the LP must file a form with the California Secretary of State. That form is called a LP-1.

California prohibits certain types of businesses from organizing as an LLC. This commonly relates to certain professionals, such as accountants, architects, physicians, attorneys, dentists and certain types of businesses, such as banks and insurance companies.

Limitation of Liability

If a business is organized as a general partnership, all of the partners can be held personally liable for the business’s debts. This means that a partner is risking more than what they contribute to the business.

If the company’s debts are greater than the value of the company’s assets, a creditor can go after the partner’s personal property, such as their personal bank accounts, other investments, cars, and real estate. In fact, a creditor does not have to go after the Partnership’s assets first but can go after the general partners first or at the same time.

A central purpose of both an LLC and an LP is to limit the owners’ personal liability, but they do not provide the same degree of protection.

With an LLC, all of the members obtain limited personal liability. The members may also participate in the management of the business and keep their limitation of liability.

In an LP, only limited partners enjoy limited personal liability. However, this only applies if the limited partner takes no active role in managing the company. A general partner remains personally liable for partnership debts.

Some LPs resolve this problem by forming a separate LLC or a Corporation to be the general partner. But this requires setting up two entities, the LLC and the LP (or Corporation), and incurring the expense of forming and operating each.