Key takeaways
- A corporation is a separate legal entity that issues shares (stake in the company) to owners and protects their personal liability
- A partnership is owned by its partners and is easier to establish and maintain
- Partnerships and some corporation types are pass-through entities, which means they avoid double taxation
If you’re considering establishing a business, you must consider what legal entity you will establish. You might already be familiar with limited liability companies (LLCs), but that’s not your only option. Your business could form a partnership or a corporation, both of which can benefit your business in different ways. The type of entity that best serves your business will depend on your appetite for personal liability risk, expectations for future fundraising, taxation and tax benefits.
To learn more, let’s look at the features between these two choices when establishing a business: partnership vs. corporation.
What is a partnership?
Partnerships by definition require two or more people. When they form the partnership as general partners, they agree to share the company’s ownership, profits, liabilities and operations.
It’s best practice to create a partnership agreement when establishing this legal entity. That document should break down ownership share by percentage across partners and each partner’s responsibilities at the company.
Partnerships can take three different forms:
| General partnerships | The basic and most common type. General partners have full decision-making authority and unlimited liability (full responsibility for debts) |
| Limited partnerships (LPs) | Limited partners get involved purely by investing money. Those limited partners have limited personal liability and aren’t responsible for business debts |
| Limited liability partnerships (LLPs) | Limited liability partnerships allow partners to be involved in managing the business but protect partners’ personal assets from liability |
As far as the IRS is concerned, all partnerships function as pass-through entities. That means they’re not subject to corporate tax. Instead, partners report the company’s profits and losses on their personal tax returns and pay any taxes owed from their own pockets.
What is a corporation?
When you create a corporation, you establish a separate legal entity. This protects your personal assets.
Unlike a partnership, in which ownership and daily operation responsibilities are shared among general partners, shareholders own corporations. All corporations issue shares (also called stock), and the number of shares an individual owns dictates their ownership stake in the company.
Corporations are complicated to establish and maintain. For example, they’re legally required to hold regular board and shareholder meetings and to submit annual reports on their business activities.
Corporations can take several forms. Two of the most common are:
| C corporation | The traditional structure in which the number of shareholders and class of stock aren’t limited and both the corporation and the shareholders pay taxes (called double taxation) |
| S corporation | This corporation is capped at 100 shareholders and one class of stock but allow the corporation to pass tax liability on to the shareholders, avoiding double taxation. Shareholders report income and losses on their personal tax returns |
Partnership vs. corporation
To help you better weigh the partnership vs. corporation situation, let’s look at those differences in detail.
| Partnership | C corporation | S corporation | |
|---|---|---|---|
| Formation | Business license (and possibly a “doing business as” (DBA), depending on your state), partnership agreement not required but recommended | Articles of incorporation, corporate bylaws, shareholder agreement and stock certificates | Articles of incorporation, S-corporation election, corporate bylaws, shareholder agreement and stock certificates |
| Ownership | 2+ people | Unlimited shareholders | 1 to 100 people |
| Taxes | Paid for on personal income tax returns | Paid for on both corporate tax returns and personal tax returns (for shareholder’s dividends from the company) | Paid for on personal income tax returns |
| Liability | Personal liability for general partners; limited liability for limited partners in an LP and partners in an LLP | No personal liability | No personal liability |
| Requirements and maintenance | Varies by state, but generally, an annual fee/tax | Annual reporting, regular board and shareholder meetings and record maintenance | Annual reporting, regular board and shareholder meetings and record maintenance |
Formation process for partnerships
Forming a partnership is much easier and cheaper than forming a corporation. Usually, you just need to secure a business license and, in many states, file a “doing business as” (DBA). You’re not even legally required to have a partnership agreement that dictates how your company breaks down between partners (although it’s recommended to establish this key document as you found your company).
Formation process for corporations
To form a corporation, you start by filing Articles of Incorporation and getting any business licenses and permits required by your state and municipality. You need to establish company bylaws, establish a shareholder agreement, issue shares and have your shareholders elect a board. To operate as an S-corp, you must also file that election (IRS Form 2553).
After you file, you’ll want to get your business organized. Get a tax ID number, or EIN, for the company. This can be done through the IRS website. You’ll also need a business bank account for your corporation. Finally, file with your state to get the proper permits and licensees needed to operate a corporation in your area.
Legal exposure differences
The main legal difference between corporations and partnerships is who is liable for legal issues regarding the business. Corporations establish a separate legal entity, limiting owners’ personal liability, while partnerships mean owners personally represent the business.
Unless your business type is eligible for an LLP, functioning as a general partner means putting your personal assets at risk.
A corporation, on the other hand, gives you liability protection. Because the corporation operates as its own legal entity, it separates the company and its owners. You can’t be held personally liable for debts, legal fees, etc. Only your business assets are on the line.
Dissolution processes for business entities
Both corporations and partnerships require you to follow multiple steps for dissolution. For both, you’ll need to file the appropriate tax paperwork with the IRS. To end a partnership, you must file form 1065, U.S. Return of Partnership Income. To end a corporation, you must file Form 966, Corporate Dissolution or Liquidation. Corporations will also need to file a corporate tax return for the year the business closes.
To close a corporation, you’ll need to get the agreement of all shareholders. For the partnership, both partners will need to agree to close the business.
The dissolution of both will also require you to take care of all accounts and employees. Pay your employees what they are owed, including remaining wages or salaries. Then, cancel your business EIN and close any business bank accounts.
It’s also a good idea to contact your state to find out if there are any specific requirements when dissolving a business in your state.
How to choose between a partnership and corporation
If you’re still weighing partnership vs. corporation for your burgeoning businesses, consider when to choose which type of business entity:
Considerations for choosing a business structure
- You might choose a partnership if you’re an individual going into business with other individuals. That way, you can outline each partner’s key responsibilities and their role in the business. It’s also a pass-through entity, meaning that the individuals pay income taxes, not the company.
- You might choose an S-Corporation if you want to protect your personal assets if the company goes under. Or you might choose the S-Corp for tax benefits and to avoid double taxation of the owner and the corporation.
- If you’re a bigger company with multiple employees, you might choose to become a C-Corporation to take advantage of added tax benefits like deducting employee benefits. You can also have unlimited business owners, making it ideal for a company with many stakeholders.
If you’re still weighing partnership vs. corporation for your burgeoning businesses, evaluate how you plan to fund your business.
Planning to seek out investors to fund your business? A corporation likely best suits your needs. While a limited partnership can allow you to bring on investors without involving them in daily operations, many investors specifically want stock. Many venture capital firms and angel investors will only invest in a company if they can get issued shares. And that means you’ll need to operate as a corporation, the only legal entity type that can issue stock.
Bottom line
The main differences between a partnership and a corporation come down to how the business is structured, its taxation and whether the owners are personally liable for business losses and debts. Partnerships are easier to form and maintain, but corporations may offer you tax benefits and legal protection that you can’t get with a partnership. Ultimately, you’ll need to weigh the features of both entities to decide which is the right fit for your business.
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