What are the differences between a limited liability company and a partnership?

What are the differences between a limited liability company and a partnership?

The main difference between an LLC and a partnership is that LLC owners are not personally liable for the company's debts and liabilities. This means that creditors of the LLC usually cannot go after the owners' personal assets to pay off LLC debts. Partners, on the other hand, do not receive this limited liability protection unless they are designated "limited" partners in their partnership agreement.

Also, owners of limited liability companies must file formal articles of organization with their state's LLC filing office, pay a filing fee, and comply with certain other state filing requirements before they open for business. By contrast, people who form a partnership don't need to file any formal paperwork and don't have to pay any special fees.

LLCs and partnerships are almost identical when it comes to taxation, however. In both types of businesses, the owners report business income or losses on their personal tax returns; the business itself does not pay tax on this money. In fact, LLC and partnerships file the same informational tax return with the IRS (Form 1065) and distribute the same schedules to the business's owners (Schedule K-1, which lists each owner's share of income).

Can I convert my existing business to an LLC?

Yes. Converting a sole proprietorship or a partnership to an LLC is an easy way for sole proprietors and partners to protect their personal assets without changing the way their business income is taxed.

Some states provide a simple form for converting a partnership to an LLC (often called a "certificate of conversion"). Sole proprietors and partners in states that don't provide a conversion form must file regular articles of organization to create an LLC.

In some states, before a partnership can officially convert to an LLC, it must publish a notice in a local newspaper that the partnership is being terminated. And in all states, you'll have to transfer all identification numbers, licenses, and permits to the name of your new LLC, including:

• your federal employer identification number
• your state employer identification number
• your sales tax permit
• your business license (or tax registration), and
• any professional licenses or permits.

Do I need to know about securities laws to set up an LLC?

If you'll be the sole owner of your LLC and you don't plan to take investments from outsiders, your ownership interest in the LLC will not be considered a "security" and you don't have to concern yourself with these laws. For co-owned LLCs, however, the answer to this question is not so clear.

First, let's consider the definition of a "security." A security is an investment in a profit-making enterprise that is not run by the investor. Here's another way to think about it: If a person invests in a business with the expectation of making money from the efforts of others, that person's investment is generally considered a "security" under federal and state law. Conversely, when a person will rely on his or her own efforts to make a profit (that is, he or she will be an active owner of an LLC), that person's ownership interest in the company will not usually be treated as a security.

How does this apply to you? Generally, if all of the owners will actively manage the LLC -- the situation for most small start-up LLCs -- the LLC ownership interests will not be considered securities. But if one or more of your co-owners will not work for the company or play an active role in managing the company -- as may be true for LLCs that accept investments from friends and family or that are run by a special management group -- your LLC's ownership interests may be treated as securities by your state and by the federal Securities and Exchange Commission (SEC).

If your ownership interests are considered securities, you must get an exemption from the state and federal securities laws before the initial owners of your LLC invest their money. If you don't qualify for an exemption to the securities laws, you must register the sale of your LLC's ownership interests with the SEC and your state.

Fortunately, smaller LLCs, even those that plan to sell memberships to passive investors, usually qualify for securities law exemptions. For example, SEC rules exempt the private sale of securities if all owners reside in one state and all sales are made within the state; this is called the "intrastate offering" exemption. Another federal exemption covers "private offerings." A private offering is an unadvertised sale that is limited to a small number of people (35 or fewer) or to those who, because of their net worth or income earning capacity, can reasonably be expected to be able to take care of themselves in the investment process. Most states have enacted their own versions of these popular federal exemptions.

For more information about SEC exemptions, visit the SEC website at http://www.sec.gov/smbus/qasbsec.htm#eod6. A quick way to research your state's exemption rules is to go to the home page of your state's securities agency, which typically posts the state's exemptions rules and procedures. To find your state securities agency, go to your secretary of state's website. The Wyoming Secretary of State's office provides a list of state websites at http://soswy.state.wy.us/sos/sos2.htm.

Copyright 2005 Nolo

DISCLAIMER: This site and any information contained herein are intended for informational purposes only and should not be construed as legal advice. Seek competent legal counsel for advice on any legal matter.

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