When choosing to start a business with a partner, one of the first questions that comes to mind is how to share profits. How you share profits will depend on the type of corporate structure. This article will focus on forming a partnership using the LLC legal structure.

Starting a business with a partner – The LLC

LLC and corporations both have the advantage of limited liability. However, the LLC has more flexibility when it comes to taxation. A LLC can be taxed as either a corporation, S corporation, partnership or sole proprietor (if sole owner).

If you and your partner choose to start a business with the LLC, you will be taxed as a partnership by default. As a partner you and your partner have membership interests
in the business. A membership interest is your share of ownership in the business. Earnings are passed through membership interests. By passed through I mean that members claim the income on their personal tax income, so how much tax you pay depends on your personal tax situation.

The operating agreement might allow for distributions to partners to cover the tax obligation. Unlike s corporations, distributions do not have to be in proportion to ownership interests. This makes the partnership a more flexible option for people looking to start a business with a partner. Distributions can be made as the partnership sees fit (for instance who contributes most), versus how much members own.

Types of partners

LLCs have general and limited partners.

General Partners

A general partner is responsible for the business and can legally bind the business into contracts. A general partner receives a schedule K-1 and not a form W-2. Salaries are taxed as a guaranteed payment. A guaranteed payment is not subject to withholding or unemployment taxes. In lieu of payroll deductions, the general partner will have to pay estimated taxes for self-employment income.

Limited Partners

A limited partner is a partner whose liability is limited to membership interests. Limited partners do not have management responsibility and are not responsible for debt incurred by the partnership. Limited partners are passive investor and for the most part the income received by limited partners are considered passive income. A limited partner may also receive a K-1 statement.

Finally, be sure to create an operating agreement before starting your LLC. It has been my experience that everyone gets along as long as there are no real assets at stake but when the money starts pouring in your best friend could become your worst enemy.