Partnerships and Limited Liability Companies

Overview

Description

A partnership is owned by a group of two or more investors who agree on how their business will operate, whereas a sole proprietorship is owned by one person. A limited liability company (LLC) can be treated as a partnership or proprietorship for tax purposes, however, its owners have limits on their liability. Agreements may include how the organization will be formed and dissolved, and all steps in between, such as distribution of income and losses. While there are advantages and disadvantages for all types of organizations, small business owners usually prefer forming a limited liability company because it limits their financial responsibility. However, many prefer a partnership, as it allows more control over daily business operations.

At A Glance

  • A proprietorship can be set up with few legal forms to file or restrictions, but the owner has unlimited liability.
  • A partnership is not a separate taxable entity, and it has a limited life with unlimited liability for its general partners.
  • A limited liability company (LLC) is popular for small businesses, in part, because of its limited liability for owners.
  • During the formation of a partnership, each partner's investment in the business is recorded with a separate journal entry to establish each partner's individual equity in the business.
  • There are two ways to divide partnership income, based on either services of the partner or services and investments of the partner.
  • A new partner can be admitted to an existing partnership by purchasing the existing interest of a current partner or by contributing new assets to the partnership.
  • A current partner can withdraw from the partnership, and his or her current interest can be sold to the existing partners or to the partnership itself.
  • When a partnership dissolves, the first step is to sell any assets in order to pay off creditors.
  • Partners' equity accounts receive whatever gains or losses incurred during a liquidation, based on an agreed-upon ratio.
  • A partnership may have a claim against a partner(s) called a deficiency, which must be calculated and recognized.
  • To show changes in the capital account of a partnership business, the statement of partnership equity is used, as it reflects performance during a given period.