Partnership vs. Corporation: What’s the Difference?

Your business structure determines many of your responsibilities as a business owner, such as what taxes you pay and your level of personal liability. Of the available business structures, also called entities, a partnership and a corporation are common options. Both can be operated by multiple people, but there are differences in how you must manage each type of business.

To help you choose the right structure for your business, we’ll help you understand the details of a partnership and a corporation.

Partnerships vs. corporations at a glance

Here’s a look at the pros and cons of different business structures and their characteristics.

What is a partnership?

A partnership is a business with two or more owners contributing money, property, labor and/or skills to the operation. The IRS considers a partnership a pass-through business, meaning all partners share the profits and losses of the company and add their portion to their personal income.

Partners must pay personal income taxes on their share of the business. Partners may also be responsible for self-employment taxes and estimated taxes, while the business may owe employment and industry-specific excise taxes.

Types of partnerships

Three types of partnerships allow you to adjust the amount of liability for business owners.

General partnership

When you establish a partnership, you’re likely forming a general partnership, which occurs when two or more people work together to earn a profit. You may not have to officially file with a government agency when you form a general partnership, depending on the state in which you live.

A general partnership does not provide any personal liability protection. You and your partner would bear the responsibility for the business’s debts, and your personal assets would be at risk if someone sues the company.

Although a general partnership doesn’t offer legal protection, it requires less paperwork and simpler tax filing than other entities. It may be a good structure for small businesses just starting out.

Limited partnership

A limited partnership offers some protection for partners. While one general partner must assume personal liability, the other partners, called limited partners, would be protected from personal liability.

You must form a limited partnership through a state government agency. This structure is best for a business with one partner who is active in daily operations and agrees to take on liability and one or more less-active partners who contribute to the business but don’t want to be fully liable. Limited partners cannot be involved in day-to-day business functions.

Limited liability partnership

A limited liability partnership provides liability protection for all partners. Although regulation of limited liability partnerships varies at the state level, the structure allows all partners to shield their personal assets. Partners also would not be responsible for the actions of other partners within the business.

What is a corporation?

A corporation is a legal entity that is separate from its owners. A corporation can act independently and make a profit, be taxed and be held legally liable. This business structure offers business owners full protection from personal liability.

A corporation is held to a higher standard of record-keeping than other business entities. Corporation owners must file annual reports, hold annual shareholder meetings, elect a board of directors to oversee the business and follow company bylaws. Because of these extra responsibilities, a corporation can be an expensive business to run.

Types of corporations

There are several types of corporations from which you could choose, but the two common options are C corporations and S corporations. Here’s how they differ:

C corporation

A group of business owners called shareholders must file articles of incorporation with their secretary of state office to form a C-corp. Shareholders have limited liability and are not responsible for the company’s debt. They can also sell shares of company stock. Your company must be classified as a C-corp if you plan to take it public.

There’s no limit to how many shareholders a C-corp can have. If an owner decides to leave or sell their shares, the company would mostly be unaffected and could continue operating.

The IRS requires C-corps to pay corporate tax. A C-corp is subject to double taxation because the company has to pay corporate taxes, while shareholders must pay taxes on the dividends they receive on their personal tax returns.

S corporation

To form an S-corp, shareholders must file articles of incorporation with the secretary of state. Like a C-corp, an S-corp provides limited liability for owners, meaning they are not responsible for the company’s debts. But an S-corp cannot have over 100 shareholders, and all shareholders must be U.S. citizens.

Like a partnership, an S-corp is considered a pass-through entity and doesn’t pay corporate taxes. The company’s profit and losses pass through to shareholders’ individual income tax returns, and their portion is taxed at the personal income tax rate. Some states impose a second tax on S-corps, so you may not be able to avoid double taxation completely.

Partnerships vs. corporations: 5 key differences

When choosing to establish a partnership vs. a corporation, consider these differences between the two entities.

1. Liability

Both S-corp and C-corp structures give business owners limited liability. All shareholders involved with the business could avoid putting their assets at risk of being personally liable for the company’s debts.

A partnership can provide similar protection if you form a limited liability partnership. If not, all or some business partners will have to remain personally liable. A general partnership does not provide any legal protection, while a limited partnership protects the assets of the limited partners but not the general partner(s).

2. Taxation

Partnerships and S-corps are classified as pass-through businesses and do not pay corporate taxes. Instead, both entities require personal income taxes and, possibly, self-employment taxes from business owners.

C-corps must pay corporate taxes when the company makes a profit. C-corps are then taxed again when paying dividends to shareholders.

Currently, C corporations pay a flat corporate tax rate of 21%. Owners of pass-through entities, including partnerships and S corps, are taxed at individual income tax rates, which vary by income tax bracket but go as high as 37%.

However, some owners of pass-through businesses are eligible for the qualified business income (QBI) deduction, which allows them to deduct up to 20% of their share of business income from their personal tax return. This reduces their top tax rate to a maximum of 29.6%.

While that’s higher than the corporate tax rate of 21%, C corp owners may still have a higher tax burden due to double taxation on profits and dividends.

3. Partnerships require two or more owners

To be considered a partnership, the business needs at least two owners. Both S-corps and C-corps can have just one owner. A C-corp can have an unlimited number of owners, while an S-corp can have no more than 100 shareholders.

4. Maintenance

Maintaining a partnership is typically straightforward, with few formal requirements beyond filing annual tax returns and, in some cases, updating the partnership agreement when necessary.

Corporations, however, must follow strict protocols to maintain separation between the entity and its owners. Both S corps and C corps have to adopt bylaws, hold shareholder or director meetings, appoint and maintain a registered agent in the state of incorporation, file annual reports with the Secretary of State’s office and pay annual fees.

5. Formation

Forming a partnership is relatively simple. For a general partnership, you need an agreement between two or more partners. That agreement doesn’t have to be in writing, but a written agreement signed by all partners can help avoid conflicts down the road.

To form a limited or limited liability partnership, you must file a form and possibly a written partnership agreement with the Secretary of State’s office.

To establish a corporation, you must typically file Articles of Incorporation with the Secretary of State’s office and adopt corporate bylaws.

How to choose the right business structure

When deciding between a partnership or a corporate structure, consider the level of personal liability you’re comfortable with. Whichever business entity you choose, you may want to work with a business advisor, attorney or accountant to make sure your paperwork is in order and that you’re making the right choice for your small business.

One of the biggest differences between the two structures is the amount of legal protection provided. A corporation offers the highest level of protection, as all owners have limited liability. In a partnership, at least one owner typically has unlimited liability. But you can get full protection if you set up a limited partnership.

Your goals and plans for the business should also impact the entity you choose. If you hope to take the company public one day, you should establish your business as a C-corp, which is the only type of business that can raise funds by selling stock in the company.