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A partnership is the default business structure for a company with multiple owners. In a partnership, co-owners report their share of the business’s income and losses on their personal tax returns. A corporation, which is formed by filing articles of incorporation, is a legally separate business entity owned by shareholders. An elected board and board-appointed officers manage the corporation.
When deciding on a business entity structure, many small business owners find themselves having to choose between a partnership vs. corporation. The choice will have important implications for your legal exposure, management structure and, ultimately, your bottom line.
A partnership is a business that’s jointly owned and run by multiple people. If you start a business tomorrow and share the responsibilities with one or more other people, you’d by default have a partnership unless you specifically choose a different structure, such as an LLC or corporation.
A partnership is a pass-through entity. This means that there’s no business income tax on a partnership. Instead, co-owners report their share of the business’s income and losses on their personal tax returns and pay their personal income tax rate.
There are three primary types of partnerships:
A general partnership is the most common type of partnership, in which co-owners are personally liable for the business’s debts and obligations. For example, if a client gets injured on business property, they can lay claim to the business assets and the owners’ personal assets as payment for their injuries.
In a limited partnership, there are two classes of partners. General partners are responsible for day-to-day business and personally liable for the company’s debts and obligations. Limited partners invest money in the business but don’t take part in day-to-day decisions. Their liability is limited to the size of their investment.
Limited liability partnership
A limited liability partnership is a special type of partnership typically reserved for law firms, doctor’s offices, accounting firms and other professional service businesses. Co-owners in an LLP are not personally responsible for the business’s debts.
The key difference among these three types of partnerships is the extent of personal liability for business debts. In a general partnership, co-owners are personally responsible for business debts. In an LP or LLP, co-owners are shielded from personal liability.
Tax treatment is the same across partnerships. There’s no such thing as a business tax on partnerships. All three types of partnerships are pass-through entities in which owners report their share of business income and losses on their personal tax returns.
A corporation is a separate legal entity. The only way to establish a corporation is to file formation paperwork with the state. The owners, called shareholders, are not personally liable for the debts or obligations of the business.
An S-corporation and C-corporation are the two main types of corporations:
The traditional type of corporation that’s subject to a corporate income tax. With C-corporations, shareholders also pay personal taxes on any dividends they receive. A C-corp can have an unlimited number of shareholders and multiple classes of stock.
Corporations can elect to be taxed as an S-corporation, which, like a partnership, is a pass-through entity. Shareholders in an S-corp report the business’s income and losses on their personal tax returns. An S-corp is limited to 100 individuals shareholders and one class of stock and all shareholders must be U.S. residents.
The management structure is similar in an S-corp and C-corp. Shareholders own the company and they elect a board of directors to make strategic decisions. The board appoints officers — like a CEO or CFO — to run the business on a day-to-day basis.
The difference in the two types of corporations is tax treatment and the number of shares you can issue. In an S-corp, you’re limited to 100 shareholders and one class of stock. In a C-corp, you can issue unlimited shares and classes of stock, making it the structure of choice for firms that want to raise money from investors by selling equity.
Key differences between partnership vs. corporation
Your choice between a partnership and corporation will affect your taxes, liability, access to capital and management structure. If you are still undecided on which business structure to choose, take some time to understand the major differences between a corporation and a partnership.
Here are the main differences between a partnership and corporation:
Business license + DBA + partnership agreement.
Articles of incorporation, corporate bylaws, shareholder agreement, stock certificates.
Articles of incorporation, corporate bylaws, shareholder agreement, stock certificates, IRS Form 2553.
Two or more people.
One or more people, no more than 100 shareholders.
One or more people, unlimited shareholders.
Personal tax + corporate income tax.
Unlimited personal liability, except for LPs and LLPs.
No personal liability.
No personal liability.
Ongoing costs and maintenance
Annual tax or filing fee (in some states).
Regular board meetings, shareholder meetings, record maintenance, annual report.
Regular board meetings, shareholder meetings, record maintenance, annual report.
One key difference between partnerships and corporations is the startup phase. Starting a partnership is easier, less time-consuming and less expensive than starting a corporation. To start a general partnership, as with any business, you may need to file for a business license or fictitious business name. But other than that, you don’t really need anything else to get started. It’s a good idea to have a partnership agreement to outline each partner’s rights and responsibilities, but not legally required.
Starting a corporation, on the other hand, requires you to check off several boxes. Along with any necessary business licenses, you have to prepare several incorporation documents, including articles of incorporation, corporate bylaws, a shareholder agreement and stock certificates. To elect S-corp status, you need to file IRS Form 2553.
Note that starting an LP or LLP is costlier and more complicated than a general partnership, but usually, a partnership requires a much smaller investment of time and resources upfront.
Ownership and management structure
As you can probably tell by now, the ownership and management structure of a partnership and corporation also varies significantly. In a partnership, each partner typically brings a complementary skill set to the table. For instance, one partner works on customer acquisition and the other on technical needs. Whatever the division of work is, though, the partners actively run and manage the business together.
A corporation has more layers of ownership and management. Shareholders collectively own the business, but don’t directly engage in company decision-making. Instead, shareholders elect a board of directors to make major strategic decisions, such as whether to target a new audience or change a company-wide policy. The board appoints officers — such as the CEO, CTO and CMO — to run the organization on a day-to-day basis.
Even more importantly, a corporation has the ability to issue stock and easily transfer pieces of ownership in the company to third parties. This makes corporations the preferred business structure of most investors. In particular, investors like C-corporations because they can purchase preferred stock in your business. As your company grows, stock will increase in value and the investor can earn a nice return on their investment. In a partnership, there isn’t a similar item of value that you can easily exchange for an investor’s money.
The next difference between a partnership and corporation is taxes. Most people place greatest emphasis on taxation because of the direct impact to a business’s bottom line. A partnership is simpler from a tax perspective, whether you have a GP, LP or LLP. Business partners simply file Schedule K-1 along with their personal 1040 tax return. Schedule K-1 lists each partner’s share of the company’s income, losses, credits and deductions.
A corporation’s tax status depends on whether you’re structured as a C-corp or S-corp. You might have heard of the term “double taxation” with regards to C-corps. This refers to the fact that C-corporations pay a corporate income tax and then shareholders have to also pay personal capital gains taxes on any dividends they receive from the company. An S-corp is a pass-through entity like a partnership, and isn’t subject to a corporate tax.
One of the biggest benefits of a corporation when talking about a partnership and corporation is that a corporation is a separate legal entity. Creditors and legal claimants can only come after your business assets, not your personal assets (though personal assets are always fair game if you’ve signed a personal guarantee on a loan). That can provide a big sense of relief, especially if you operate in a higher-risk industry, like construction or shipping.
A general partnership leaves you open to personal liability for business debts or business lawsuits. Limited personal liability is available to limited partners in an LP and to all partners in an LLP, but those aren’t suitable arrangements for all types of businesses.
Ongoing costs and maintenance
With partnerships, ongoing costs and maintenance requirements are minimal. Some states, including California and New York, charge an annual tax or annual filing fee. But other than that, there’s really not much in the way of paperwork that you need to file.
In contrast, corporations are highly regulated. You need to have regular board and shareholder meetings, document meeting minutes and maintain records of important resolutions. Corporations also have to file an annual report documenting their activities over the previous year.
How to choose between partnership and corporation
The five differences outlined above should help you decide between a partnership and a corporation for your business structure. Ultimately, you can distill the decision down to three things — your tax bill, your preferred method for raising capital and your appetite for legal risk.
Minimize your tax bill
It’s not possible to say that a certain type of business structure guarantees lower taxes. There are too many business-specific variables — such as your exact income level, business expenses and deductions — that affect your final tax burden. The Trump tax reform bill cut the tax rate for C-corporations to a flat 21%. It also lets pass-through entities, like S-corps and partnerships, deduct 20% of their business income before calculating taxes. An accountant or tax lawyer will be able to crunch the numbers with you and figure out which is the better option for your company.
A C-corporation is subject to double taxation, meaning they pay a flat income tax rate of 21%, and shareholders are taxed on their personal tax returns when profits are distributed as dividends. However, a C-corporation but also enjoys more tax savings than other types of businesses. For example, a C-corporation can more easily shift income around to different fiscal years. Also, a C-corporation can deduct payroll taxes and 100% of fringe benefits given to employees.
“In my previous company that I founded, I elected to organized as a C-corporation," says Michael Osteen, chief investment strategist at Port Wren Capital, LLC. "The C-corp not only provided legal protection, but also reduced my tax liabilities. For example, the amount you can allocate to your retirement account is much higher and the corp can write it all off. Any bonuses are deductible. You can deduct your medical insurance expenses as a corp and deduct the part of FICA that the corp pays. The wages paid to your employees are deductible. All in all, the corp provides a better tax shelter.”
Consider how you want to raise capital
Raising money has a lot to do with what type of business structure you choose. If you have your own savings or plan to raise money through business loans, then any business structure will work.
However, if you want to raise money from investors, a corporation is the better choice and might even be required. Many angel investors and venture capitalists won’t invest money in a business unless they can receive stock in a corporation in exchange for their support. Stock is the reason that investors can make 20x to 40x returns on their initial investment.
Weigh your appetite for legal risk
Some entrepreneurs are more open to taking risks than others. If you have a general partnership, you need to realize that your personal assets — like your car, home and personal bank accounts — are open to creditors of the business. This might not be a scary proposition when you’re first starting out and don’t yet have a steady revenue stream. But once they start making a significant amount of money, most business owners protect themselves by establishing a corporation.
Of course, the trade-off is that it’s costlier and more time-intensive to create and maintain a corporation. But for most entrepreneurs, the cost and time involved are worth the peace of mind.
“Partnerships typically have very simple management structures. In a general partnership, partners typically make decisions based on majority vote based on share of ownership," says David Reischer, attorney and CEO of LegalAdvice.com. "Also, partnerships have no formal requirement to have regular meetings and therefore the administrative operation of a partnership is relatively easy to run. That said, our online business is set up as an S-corp, which offers protection of personal assets of our shareholders. A shareholder is not personally responsible for the business debts and liabilities of the corporation.”
Once you decide, set up your partnership or corporation
Once you decide between a partnership or corporation, it’s time to actually set one up! To form your partnership, contact your state’s or city’s business filing department and find out if your industry requires a business permit. You’ll also need to file a doing business as/fictitious business name if you’re operating under a trade name.
For a corporation, you’ll need to get started by filing articles of incorporation. After that come your corporate bylaws, stock certificates and shareholder agreements. Most small business owners use an online legal service like LegalZoom or hire a business attorney to help them comply with corporate formalities.
A version of this article was first published on Fundera, a subsidiary of NerdWallet.