The main differences between a partnership and a corporation are how liability is distributed, how the taxes are assessed, the flexibility in running and selling the business, and how it raises capital. Partnerships are generally more flexible than corporations, but they can be harder to sell. They also leave owners open to legal liability. Corporations protect their members from legal liability and often have an easier time raising money, but they have less flexibility and may have to file a lot of paperwork with the government in their area. Sometimes engaging in a limited liability company or a specific type of corporation, like an S corporation, can offset some of the bad points of each model.
Personal Risk
Corporation shareholders are only held liable for their actual investment in the company, because the corporation is seen as a separate legal entity. This protects their personal accounts and assets. General partnerships do not have this level of protection because the company is not its own entity, making them liable for its actions and debt. For example, if a corporation goes out of business, then its shareholders only lose what they put into the business, whereas owners in a partnership could be responsible to repay debt to creditors from personal accounts.
Taxes and Income
Partnerships are generally easier to create and offers a simplified approach to reporting taxes. Owners split the profit and file this income on their personal income tax forms. Lawyers are often involved in creating the agreement between owners so ownership percentages, roles, and expectations are clear to everyone involved. Corporations must file taxes separately than its owners since they are separate entities. Equity is divided amongst the owners based on the number of shares held in the company.
Flexibility
A corporation is generally a little less flexible than a partnership in terms of how its structured and run and in terms of changing ownership. Members of a corporation have to act in accordance with the corporation’s charter, and the business is run by a board of directors, rather than by direct input from the owners. In some regions, corporations are also required to file certain types of documents, like meeting minutes, every year with the local government. Corporations are more flexible in one aspect, however: it is much easier to transfer ownership of part of a corporation than it is to sell part of a partnership.
Partnerships are generally less structured, since they only have to adhere to a partnership agreement rather than a charter. Decisions are made by partners, rather than by a board of directors, and they usually don’t have to file as much paperwork with local governments. It is more difficult to sell this type of business though, since each part of the business has to be individually transferred or sold. This requires a lot of paperwork, and usually has to be overseen by a lawyer.
Capital and Credit
The way each of these types of business structures also raises capital in different ways. Corporations raise money by selling financial instruments like stocks and bonds. A partnership has to raise money from its members. It can do this by having the members contribute more, or by getting new members. It can also raise money by getting a loan. In terms of credit, since a corporation is considered a separate entity, it can have its own line of credit, whereas a partnership may not be able to, depending on the credit history of the partners.
Limited Liability Partnerships and Companies
Limited liability partnerships can be created so that only at least one person has unlimited liability, offering similar protection as owners of a corporation. Under this agreement, partners are not held responsible for the actions or negligence of the other partners. Depending on the country or jurisdiction, it may be possible for this type of company to offer this level protection to all owners of the company.
Halfway between a corporation and a partnership, a limited liability company allows for pass-through taxation and a less rigid structure of operating than a corporation. This entity could be an individual, partnership, or a corporation. Rules regarding partnerships and corporations are constantly changing, so advice from a lawyer or accountant may be necessary when deciding the options available for creating a limited liability company.
Types of Corporations
General and tax liability can differ between different types of corporations. In the US, some states offer owners the choice of filing for a C corporation or an S corporation. C corporations are the most common type of corporation found in the US, and pay taxes separately from their shareholders. Double taxation can occur in this type of situation, because the corporation must pay taxes on its profits as well as on dividends. This can sometimes be avoided by paying shareholders salaries with fringe benefits rather than dividends.
A C corporation can also decide to change into an S corporation. This is generally done by filing a 2553 IRS form. S corporations are taxed in a pass-through manner, allowing the shareholders to pay taxes like owners in a partnership. Shareholders report the corporation’s profit or loss on their individual tax returns.