As a small business owner, you want to know all the business structure options available so you can start your company in the best possible way. These options include the limited liability company (LLC) and limited liability partnership (LLP) structures.
But, what are these structures and how do they differ? The difference between an LLC and an LLP involves more than just terminology; they come with several legal differences as well. Read on to learn about the basic structure and key differences of LLPs and LLCs.
LLPs vs. LLCs: An Overview
In setting up a business, one important decision you must make involves choosing the type of company you want to form.
This is where many people feel overwhelmed and confused. Often, one of the main causes of this confusion is a lack of understanding of the various business structures – including LLCs and LLPs.
What is an LLP?
An LLP is basically a general partnership that combines the benefits of a corporation and a partnership. Because an LLP is registered as a separate business entity, it’s understandable why people might confuse LLPs with partnerships.
While the Internal Revenue Service (IRS) treats LLPs as “pass-through entities” for tax purposes by default, LLPs don’t have the option to elect corporate taxation status like an LLC does.
What is an LLC?
An LLC is a business entity that combines the limited liability privileges of a registered corporate company with the tax benefits enjoyed by a business partnership. It can have one or more members, and it’s often the structure chosen by small businesses and startups.
By default, the IRS treats LLCs as “pass-through entities” when it comes to taxation. LLCs also have the flexibility to instruct the government to tax them as a C corporation (C corp) or an S corporation (S corp).
Key Differences Between LLPs and LLCs
LLPs and LLCs differ in five key areas: formation, liability protection, ownership, management structure, and taxation.
LLP vs. LLC: Formation
Some states restrict the type of businesses that may form an LLP while LLCs generally face no such restrictions in all 50 states. Some states, such as California, Nevada, New York, and Oregon, only allow professionals in specific industries to form an LLP by registering as a Professional Limited Liability Partnership (PLLP).
While filing an LLC’s Articles of Organization is straightforward, an LLP’s formation document must list the protected personal assets of each partner as well as the liability protections each partner has if another partner commits a negligent act. This can make the LLP formation process a bit more complex.
LLP vs. LLC: Liability Protection
While both LLCs and LLPs provide limited liability protection to their members and partners, respectively, there are a few technical differences. The protection isn’t entirely equal.
In an LLP, each partner has personal liability for their own respective negligence. This means they won’t be liable for another partner’s mistakes. In other words, they have liability protection from the wrongs committed by other partners. Their risk extends only to the extent of their capital investment in the company.
In an LLC, each member has protection from personal liability for any business debts or claims. This means the creditors or other individuals to whom the company owes money can’t file a suit against any of the members to recoup those debts. The members are only liable to the extent of their personal investment in the company.
LLP vs. LLC: Ownership
Some states restrict ownership of LLPs to licensed professionals, such as doctors, accountants, and lawyers. In those states, these professionals may not form a standard LLC. Most states impose very few, if any, restrictions on LLC members, which can include other companies, non-U.S. residents, trusts, and other entities.
In California and several other states, for example, some professions in architecture, accounting, and health care may not register as LLCs. If your business belongs in these industries and you’ve registered it as an LLC, you can’t do business in California and other states with similar rules. This means that if your company falls within these industries and you want the simplicity and affordability of an LLC, you must register as an LLP instead in order to conduct business nationwide.
Another kind of industry-related limitation also exists in some states. In California, Nevada, and Oregon, for example, only legal, accounting, and architecture professionals may form LLPs. Because there’s little difference between LLCs and LLPs in terms of taxation and paperwork, this rule isn’t as limiting as it looks. Another distinction is that, in some states and counties, LLPs may be required to determine a “general partner.” Unlike the other partners, this person will have “unlimited liability.” In other words, if the partnership acquires debt or faces a lawsuit, the general partner may have to pay with his or her own personal assets if the company assets aren’t enough to cover the costs.
There’s no upper limit to how many owners an LLC or LLP can have, but LLPs must have at least two and LLCs may have just one. Also, LLC owners are called “members” while LLP owners are called “partners.”
LLP vs. LLC: Management Structure
In terms of management, an LLC may have a single member or multiple members. An LLP, on the other hand, must have at least two partners.
In addition, an LLC is managed and bound by the Operating Agreement its members create. That document usually contains the financial structure of the company along with the respective contributions of its members, the profit distribution details, and more. It also prescribes who can make management decisions for the company.
An LLC can either choose to have all of its members involved in its management or can assign a single manager to make decisions for the company.
In contrast, the partnership agreement entered into by each partner governs an LLP. The general rules of any partnership agreement apply here.
LLP vs. LLC: Taxation
Because the IRS taxes LLPs as a partnership, they don’t pay income tax at the company level. Instead, LLP profits pass through to the partners who pay personal income tax on their share.
LLCs also have this form of “pass-through” taxation by default, but they have the flexibility to elect taxation as a C corp or an S corp as well.
Beyond the key differences outlined above, there’s not much else that distinguishes LLCs from LLPs. Depending on your state, you might not have a choice between the two.
With either option, you’ll still be able to choose how the IRS treats your company for tax purposes, file equally simple forms, and pay roughly the same amount in fees. Ultimately, your decision may depend on the field in which you operate and your state’s business laws.
LLP vs LLC FAQ
Which is better — an LLC or LLP business structure?
For the benefits of limited liability and tax considerations, most small businesses register as LLCs. But, depending on the state of operation, tax laws may vary unfavorably for LLCs — an important consideration. For professional groups of at least two people, though, LLPs may offer the better option.
Is LLP the same as LLC?
No. A limited liability company (LLC) is a business structure that works well for a wide range of businesses, whether they have a single member or multiple members. A limited liability partnership (LLP) is a business structure that typically caters to a specific group of professions. Some states limit LLP ownership to licensed professionals, such as the owners of a law firm, medical practice, or real estate agency.
When should you use an LLP or LLC business structure?
If your top priority is flexibility for tax purposes, an LLC may provide the better, long-term choice for your business because it enables you to elect an S corp or C corp tax status. If you’re more concerned about financial or legal risks due to a partner’s actions, consider forming an LLP.