LLC vs. LP vs. S-Corp: A Guide for Business Owners

When comparing a Limited Liability Company (LLC), a Limited Partnership (LP), and an S Corporation (S-Corp), it is essential to consider their differences in terms of structure, liability, management, and taxation for different business needs. Each entity type offers distinct advantages and disadvantages depending on the circumstances and objectives of the business owners. 

Structure 

LLC Structure

An LLC is a flexible business structure that can be owned by one or more members, who may be individuals, corporations, other LLCs, or partnerships. LLCs are governed by state statutes and are known for their operational flexibility. LLCs must file Articles of Organization with their state, providing key details such as the LLC's name, address, and the registered agent's information. There is a one-time formation filing fee, which varies by state.  

While not always legally required, LLC members typically create and sign an operating agreement. This agreement is essential as it outlines the LLC's ownership structure, member roles, and operational procedures. It should also include information on profit sharing, voting rights, management, and procedures for adding or removing members.  

LP Structure

An LP must have at least one general partner and one or more limited partners. The general partner manages the LP’s day-to-day operations. In contrast, the limited partners contribute capital to the business but do not have a role in management decisions or day-to-day operations.  

LPs need to file a Certificate of Formation, also known as the Certificate of Limited Partnership, with their respective state. This certificate includes the LP's name, principal office address, the name and address of the registered agent, and the names of the general and limited partners. It is filed with the state's Secretary of State or similar business filing agency. Just like with LLCs, there are one-time formation filing fees for LPs, which vary by state.  

LPs also need to create a Limited Partnership Agreement to outline the rights, responsibilities, profit share, and obligations of the general and limited partners, as well as capital contributions, distribution of profits and losses, management duties, and procedures for adding or removing partners.  

S-Corp Structure

S-Corps have a corporate structure with directors, officers, and shareholders. The board of directors oversees corporate affairs and makes major decisions but does not manage day-to-day operations. Shareholders of S-Corps must be individuals, certain trusts and estates, and cannot be partnerships, corporations, or non-resident aliens. 

To register an S-Corp, you must file Articles of Incorporation with the Secretary of State or a similar state agency. In addition, S-Corps need to create corporate bylaws to govern the corporation's operations and outline its structure. The bylaws include information on shareholder meetings, the process for electing directors, and the roles and responsibilities of directors and officers.  

An S corporation may have only one class of outstanding stock. The shares may have different voting rights, but they must confer identical rights to distribution and liquidation proceeds as per Code Sec. 1361(b)(1)(D) and (c)(5); Reg. §1.1361-1(l). For tax purposes, the S-Corp must file Form 2553 requesting S-Corp treatment from the IRS. 

Liability 

LLC Liability

The protection from personal liability for LLC members is codified in state LLC statutes, which consider an LLC a separate legal entity from its members. This, in turn, allows the LLC to own property, incur debts, and conduct business in its name rather than in the names of its members. As a result, members of an LLC are only liable up to the amount of their investment in the LLC.

This means that if the LLC incurs debt or faces a lawsuit, the members' personal assets are protected. Creditors of the LLC can only pursue the LLC's assets to satisfy the business's debts. 

LP Liability

In a Limited Partnership structure, general partners are fully liable for the partnership's debts and obligations. This means their personal assets can be used to settle the partnership's debts.

Limited Partners, on the other hand, limit their liability to the extent of their investment in the LP. This means they can lose their investment, but their personal assets are protected from the partnership's liabilities. 

S-Corp Liability

In an S-Corp, shareholders have limited liability protection, similar to an LLC. Since an S corporation is considered a separate legal entity from its shareholders it means that the corporation itself is responsible for its own debts and obligations. This simple legal distinction is what shields shareholders from being held personally responsible for the corporation's liabilities.

However, maintaining this protection requires careful adherence to corporate formalities, including holding annual shareholder meetings, maintaining meeting minutes, and following corporate governance rules to ensure that the corporate veil remains intact. 

Management 

LLC Management 

LLCs can be managed by the members (member-managed) or by managers who may not be members (manager-managed).  

In a member-managed LLC, all members (owners) actively participate in the day-to-day management of the business.

In a manager-managed LLC, members appoint one or more managers to handle the LLC’s daily operations and decisions. The managers can be members of the LLC or outside parties.  

LP Management 

The management of a Limited Partnership involves distinct roles and responsibilities primarily divided between two types of partners: general partners and limited partners.

General partners handle operational day-to-day responsibilities and they also have the authority to bind the partnership in contracts and agreements with third parties.

Limited partners do not have the authority to make decisions affecting the general management of the LP. However, changes in the nature of the business or decisions to dissolve the partnership typically require the consent of both general and limited partners, depending on the terms of the partnership agreement. The partnership agreement and state laws play critical roles in defining and regulating these relationships and responsibilities. 

S-Corp Management 

The management of an S-Corp involves a structured hierarchy and adherence to corporate formalities (as mentioned above). S-Corp shareholders have the right to elect the board of directors and vote on major corporate decisions. However, their day-to-day involvement in management is typically limited.

The board of directors is elected by the shareholders and oversees the corporation's overall direction and makes major policy and financial decisions. The board is responsible for appointing officers such as the President, Chief Executive Officer (CEO), Chief Financial Officer (CFO). The officers are responsible for the day-to-day management of the corporation and execute the policies and decisions made by the board. 

Taxation 

LLC Taxation

By default, LLCs are treated as a pass-through entity for federal tax purposes and the income is passed through to the members, who report it on their personal tax returns. However, LLCs can make a check-the-box election by filing Form 8832 with the IRS which would allow it to be taxed as a C-Corporation or an S-Corporation. This flexibility allows LLCs to optimize their tax situation.   

An LLC also allows far more flexibility in its allocation of income to its members. The allocation terms defined and agreed upon in the LLC agreement allow its members to invest their money in a way that is most tax-advantageous to them. 

LP Taxation

LPs, similar to LLCs, pass through their profits and losses to the partners who report them on their personal tax returns. General partners are subject to self-employment taxes on their share of the partnership's income because they are actively involved in managing the business.

In contrast, limited partners may not be subject to self-employment taxes on their share of the profits, provided they are not actively involved in the business operations. 

Related Content: Limited Partners May Not Be Exempt From Self-employment Contributions Act (SECA) Taxes

S-Corp Taxation

S-Corps combine elements of both corporate and pass-through taxation, making it a hybrid entity. The IRS simultaneously views an S-Corp as having a corporate governance structure, yet includes the passthrough capabilities of its income to the shareholders. Unlike C corporations, which are taxed at the corporate level, S corporations are not subject to federal income tax at the entity level. S-Corp shareholders can also be employees of the business and receive W-2 income in addition to their distributive share of income from the business.  

The largest advantage an S-Corp holds over an LP or LLC is the avoidance of self-employment taxes. A shareholder’s distributive share of income is not subject to self-employment taxes and therefore can result in significant tax savings. Only the shareholder’s W-2 income is subject to Social Security and Medicare taxes. Given this benefit to S-Corp shareholders, the IRS will monitor the salaries paid out to the shareholders to ensure they are reasonable and not set artificially low to evade paying the Social Security and Medicare taxes.  However, with proper planning and documentation, a balanced approach can yield tax efficiencies.  

Determining Suitability

Conclusion 

Choosing the proper business structure depends on many factors, including the number of owners, the level of protection from liability each owner needs, the tax implications, and the type of business being conducted. LLCs offer great flexibility and are generally easier to set up and maintain. LPs are excellent for projects with silent partners who prefer not to be involved in day-to-day management. S-Corps provide benefits in self-employment tax situations but with ownership and shareholder-type restrictions. Each business owner should consider these factors considering their specific business needs and goals. 

Evolved is a tax compliance and advisory firm with offices in New York City, Philadelphia and Stamford, serving clients nationally throughout the US.  We provide tax provision, private equity and venture capital services alongside advisory for high net-worth tax and family office tax.