What Is a Partnership? Types & Formation
If you’re thinking about starting a business with someone else, you’ve probably wondered about partnerships. A partnership is the simplest way for two or more people to own a business together — no paperwork required with your state, shared profits and losses, and everyone’s personally liable for the business debts.
The short answer: If you’re testing a simple business idea with a partner and keeping things informal, a general partnership works. If you want liability protection or plan to grow beyond a small operation, form an LLC instead.
Quick Comparison: Partnership vs LLC
| | General Partnership | LLC |
|–|–|–|
| Formation | Automatic when you start business together | File articles of organization with state |
| Liability | Personal liability for all partners | Limited liability protection |
| Taxation | Pass-through to partners | Pass-through to members |
| Paperwork | Partnership agreement (recommended) | Operating Agreement + state filing |
| Best For | Simple ventures, temporary projects | Most small businesses wanting protection |
General Partnership Explained
A general partnership forms automatically when two or more people start a business together. You don’t file anything with the state — if you and your friend start selling handmade soap at farmers markets and split the profits, congratulations, you have a partnership.
How Partnerships Are Taxed
Partnerships use pass-through taxation. The business doesn’t pay taxes — instead, profits and losses flow through to each partner’s personal tax return based on their ownership percentage.
If your partnership makes $100,000 profit and you own 50%, you’ll report $50,000 as income on your personal return. You’ll also pay self-employment tax (15.3%) on your share of the profits.
Real Pros and Cons
Pros:
- Zero formation costs or state paperwork
- Complete flexibility in profit sharing and decision making
- Tax losses offset your other income
- Easy to dissolve
Cons:
- Each partner has unlimited personal liability for all business debts
- Any partner can legally bind the entire partnership to contracts
- Business dissolves if one partner leaves or dies
- Harder to get business loans or credit
Best for: Two friends starting a consulting practice, family members running a small retail shop, or any simple business where the partners trust each other completely and aren’t worried about major liability risks.
Limited Liability Company (LLC) Explained
An LLC is a legal entity you create by filing Articles of Organization with your state. It gives you liability protection while keeping the tax benefits of a partnership.
How LLCs Are Taxed
By default, LLCs are taxed exactly like partnerships — pass-through taxation with self-employment tax on all profits. The difference is you get liability protection for roughly the same tax treatment.
You can also elect S-Corp taxation for your LLC, which can save on self-employment taxes once you’re profitable enough.
Real Pros and Cons
Pros:
- Your personal assets are protected from business debts and lawsuits
- Flexible management structure and profit sharing
- Can elect different tax treatments as you grow
- Business continues even if members leave
- Easier to get business credit and loans
Cons:
- State filing fees ($50-$500 depending on the state)
- Annual state requirements in most states
- More paperwork than a simple partnership
- Some states charge annual fees or franchise taxes
Best for: Any business where liability is a concern, partners want formal structure, or you plan to grow beyond a simple operation.
The Tax Difference — This Is the Big One
Let’s say you and your partner run a marketing consultancy that nets $120,000 annually, split 50/50.
As a Partnership:
- Each partner reports $60,000 income
- Each pays income tax on $60,000 (varies by tax bracket)
- Each pays self-employment tax: $60,000 × 15.3% = $9,180
- Total self-employment tax for both: $18,360
As an LLC (default taxation):
- Exactly the same as partnership taxation
- Each member pays $9,180 in self-employment tax
As an LLC electing S-Corp taxation:
- Pay each partner a reasonable salary (let’s say $45,000 each)
- Salary subject to payroll taxes: $45,000 × 15.3% = $6,885 each
- Remaining $15,000 per person distributed as profits (no self-employment tax)
- Self-employment tax savings: $2,295 per person annually
The S-Corp election becomes valuable when your LLC is profitable enough that the self-employment tax savings exceed the costs of running payroll and the additional paperwork.
When to talk to a CPA: If your business is netting over $60,000 annually, or if you’re in a high-liability profession like consulting or construction.
Ownership, Management & Raising Money
General Partnership
Partnerships offer complete flexibility. You can split ownership 50/50, 60/40, or any way you want. You can also give one partner more decision-making power while another gets more profits.
But partnerships can’t issue stock or bring on investors easily. If you want to raise money, you’ll likely need to convert to an LLC or corporation first.
LLC
LLCs are almost as flexible as partnerships but more investor-friendly. You can have different classes of membership interests, bring on silent investors, and structure complex ownership arrangements.
Most angel investors and VCs prefer LLCs over partnerships because the legal structure is more familiar and predictable.
Which One Should You Pick?
Here’s our decision framework based on hundreds of business formations:
Freelancer/consultant earning under $40K annually: General partnership works if you trust your partner completely. Otherwise, LLC for protection.
Service business with 2-3 partners: LLC. The liability protection is worth the modest filing fee, especially in consulting, marketing, or professional services.
Profitable business earning $60K+ net: LLC with S-Corp election. The self-employment tax savings will likely exceed the additional costs.
Any business with liability concerns: LLC. This includes restaurants, retail stores, construction, or anything where customers visit your location.
Planning to raise investment: LLC. Investors expect formal business entities with clear ownership structures.
E-commerce/online business: LLC. You’re selling products to strangers on the internet — you want liability protection.
We’re opinionated here because we’ve seen too many partnerships run into problems that a simple LLC filing would have prevented.
Can You Switch Later?
Yes, and it’s common. Most businesses that start as partnerships eventually convert to LLCs.
Partnership to LLC: File Articles of Organization in your state and transfer business assets to the new LLC. The IRS treats this as a non-taxable conversion if done properly.
LLC to Corporation: Also possible, though more complex for tax purposes.
The key is planning the conversion before you need it. Converting during a lawsuit or financial crisis is much harder.
For International Founders
If you’re not a U.S. resident, partnerships and LLCs work differently for you.
Partnerships: Foreign partners in U.S. partnerships face complex tax filing requirements. You’ll likely need to file U.S. tax returns and may owe U.S. taxes on partnership income.
LLCs: Similar issues — foreign LLC members typically must file U.S. tax returns.
Better option for international founders: Many non-U.S. residents form a U.S. corporation instead, which can be more tax-efficient depending on your home country’s tax treaties with the U.S.
If you’re an international founder, talk to a CPA familiar with cross-border taxation before choosing your entity type.
Frequently Asked Questions
Do I need a partnership agreement?
Legally, no. Practically, yes. Without an agreement, your state’s default partnership laws apply, which might not match what you and your partner actually want. A simple partnership agreement covers profit sharing, decision making, and what happens if someone wants out.
how much does it cost to form an LLC vs partnership?
Partnerships cost nothing to form. LLCs require state filing fees ranging from $50 (Kentucky) to $500 (Massachusetts). Most states charge $100-200.
Can a partnership have just one owner?
No. By definition, partnerships require two or more owners. If you’re flying solo, you want a single-member LLC or sole proprietorship.
What’s a limited partnership?
A limited partnership has general partners (who run the business and have unlimited liability) and limited partners (who invest money but don’t manage day-to-day operations). They’re less common than general partnerships or LLCs.
Do partnerships need an EIN?
Yes, if you have employees or multiple partners. Single-member LLCs can sometimes use the owner’s SSN, but partnerships always need their own EIN (Employer Identification Number).
Can partners have different ownership percentages?
Absolutely. You can split ownership any way you want — 50/50, 60/40, 70/20/10 with three partners, whatever works for your situation.
What happens if my business partner dies?
In a general partnership, the partnership legally dissolves, though the surviving partner can often continue the business. In an LLC, the business continues operating and the deceased member’s interest passes to their heirs according to the Operating Agreement.
Are there ongoing requirements for partnerships?
Partnerships must file an annual tax return (Form 1065) if they have more than one partner, but there are no state filing requirements since you never registered with the state in the first place.
The Bottom Line
Partnerships work for simple, low-risk ventures between people who trust each other completely. But for most businesses, an LLC provides better protection and more options as you grow.
The filing fee for an LLC — usually under $200 — is small compared to the potential cost of personal liability in a partnership. We’ve helped thousands of business owners make this choice, and the vast majority choose LLCs once they understand the liability risks.
Ready to get started? We handle LLC formation in all 50 states, including your Articles of Organization filing, EIN registration, and ongoing compliance support. Our step-by-step process walks you through entity selection and gets your business properly formed and ready to operate. [Get started here](https://www.businessformations.com/get-started/) and we’ll help you choose the right structure for your specific situation.
