LLP vs LLC

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. Continue reading this LLP vs LLC article to learn about their basic structures and key differences.

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, though LLCs also have the flexibility to instruct the government to tax them as a C corporation (C corp) or an S corporation (S corp).

LLP vs LLC Key Differences

In the sections below, we’ve broken down the five key areas in which LLPs and LLCs differ.

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.

Liability Protection

While both LLCs and LLPs provide limited liability protection to their members and partners, respectively, there are a few technical differences and the protection isn’t entirely equal.

In an LLP, each partner has personal liability for their own respective negligence, which means they won’t be liable for another partner’s mistakes. In other words, they have limited personal liability for the wrongs committed by other partners but can be held liable for their own wrongdoings — meaning their risk only extends to the extent of their capital investment in the company.

By contrast, each member of an LLC has protection from being held personally liable 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.

However, if one LLC member commits a negligent or illegal act, all other members can also potentially be held personally liable.

Ownership

TIn terms of ownership, there are a number of key differences between LLCs and LLPs. Outside of the fact that LLC owners are called “members” while LLP owners are called “partners”, these business entities are required to have a different number of minimum owners — one for LLCs and two for LLPs.

On top of this, some states restrict ownership of LLPs to licensed professionals, such as doctors, accountants, and lawyers — meaning these professionals may not form a standard LLC. Instead, they will have to form a professional limited liability company (PLLC).

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, you won’t be able to do business in California and other similar states if you’ve registered it as an LLC.

Finally, while the rules regulating LLC ownership are more standardized across the state, there is much more variation in regulations managing LLPs. For example, some states and counties require LLPs to appoint a “general partner” to have “unlimited personal 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.

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.

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.