Are you launching a company with partners? Consider starting your business as a limited liability company (LLC) or a limited liability partnership (LLP).
Each business structure offers specific liability protection and income tax benefits and differs in management requirements and insurance obligations. Since regulations vary by state, your local enterprise office is the best source of regionally-specific guidance.
In general, here’s what business owners should know about LLCs and LLPs.
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What is an LLP?
An LLP shields business partners from personal liability.
Favored by professional businesses such as medical offices, law firms, and accounting firms, LLPs let partners share management responsibilities while limiting their personal risk. State rules vary widely, but frequently restrict LLPs to licensed professions.
Be sure to check with state officials, typically in the secretary of state’s office, to determine the rules where you operate.
Advantages
As a hybrid business structure, LLPs offer several advantages:
- Liability protection: Partners aren’t personally responsible for business debts or partner actions.
- Separate legal entity: Considered a person under the law, an LLP can own property and enter contracts.
- Flexible ownership: Two companies, a.k.a. corporate partners, can own an LLP.
- Profit distribution: Partners decide how to share profits.
- Cost savings: It’s less expensive to form an LLP than a corporation.
Disadvantages
- Limited availability: Not all states allow LLPs, and each regulates them differently. For example, only certain licensed professionals in Nevada can operate as an LLP.
- Regulatory burdens: Many jurisdictions require LLPs to publically file annual reports, including profit, loss, and partner income details.
- Minimum two partners: Theentity will be dissolved if one member leaves.
- Pass-through taxation: Partners pay taxes individually.
What is an LLC?
LLCs are popular business structures in the United States because they offer the liability protection of a corporation and the flexibility of a partnership or sole proprietorship. “LLCs are commonly used for small to medium-sized businesses,” says Justyna Mueller, partner at James Moore Certified Public Accountants and Consultants. “The interesting thing about them is that the US has no tax code for them. LLCs need to choose how they want to be taxed.”
An LLC’s owners can choose to be taxed as a C corporation or a pass-through entity.
“As a pass-through entity, you’re required to file a tax return, but the entity itself doesn’t pay any tax. Instead, the income it makes is recorded on the owners’ individual income tax return,” Justyna adds. “LLCs are easier to manage because they have fewer state-imposed requirements for running your business.”
Advantages
- Asset protection: If the LLC goes bankrupt or is sued, the members’ personal assets (i.e., houses, cars, and bank accounts) are protected.
- Simplicity: LLCs require minimal paperwork to establish, and annual shareholder meetings aren’t needed.
- Tax benefits: Optimize your financial strategy with the tax classification that works for you, including pass-through, which sidesteps double taxation.
- Freedom: Add any number of members, regardless of citizenship, and adjust ownership percentages easily.
- Profit distribution: Divide profits based on contributions or other agreed terms.
- Privacy: Ideal for investors desiring anonymity, LLCs don’t require public disclosure of ownership details.
Disadvantages
- Liability exceptions: Personal liability protection doesn’t apply to fraud or corporate misconduct.
- Self-employment taxes: Often waived for corporations, you’ll likely be on the line for self-employment taxes as an LLC owner.
- Renewal costs: Your business license and other renewal fees may be higher as an LLC than as a LLP.
LLC vs. LLP differences
LLCs and LLPs are similar but not synonymous.
| LLC | LLP | |
|---|---|---|
| Formation | Suitable for single or multi-owner. | Only for multi-owner businesses. |
| Management | Member-managed or manager-managed. | Managed by partners. |
| Ownership | Can be owned by individuals, entities, or foreigners. | Owned by licensed professionals. |
| Taxation | Pass-through, but can opt for corporation. | Default as pass-through entity. |
| Liability Protection | Limited personal liability; exceptions apply. | Limited personal liability; shields from partners. |
| Existence | Generally perpetual. | Duration defined, may need renewal. |
Formation
LLCs are available to single- and multi-owner businesses, but the LLP structure is unavailable to single owners. Both structures require registering your business with the state, typically through the secretary of state’s office.
Management
LLCs and LLPs are both legal entities. Members can supervise an LLC (member-managed), as can member-appointed managers (manager-managed). Partners oversee LLPs, although some may take on more management than others.
Ownership
With LLCs, ownership and voting rights are flexible. For example, individuals, corporations, trusts, or foreign entities can own an LLC.
LLPs are less versatile. In many states, only licensed professionals in specific industries, such as law, accounting, medicine, and architecture, can form an LLP.
Taxation
LLCs enjoy greater tax flexibility than LLPs and can elect for taxation as a corporation—usually an S corp.
S corporation LLC owners can choose to take a salary and pay Social Security and Medicare taxes on only that amount. Remaining business profits are not subject to self-employment tax.
In an LLC without an S election (like a general partnership), members pay self-employment taxes on their share of total earnings.
Liability protection
LLCs and LLPs both offer strong liability protection.
LLP partners are shielded from each other’s malpractice claims in many states. In LLCs, members can be held liable for each other’s members’ intentional wrongdoing but may be off the hook if they were ignorant of employee or member misconduct when it happened.
Existence
Most states allow LLCs to exist in perpetuity, meaning they can go indefinitely. Meanwhile, LLPs have a set lifespan, requiring renewal or dissolution after a predetermined period.
States differences
Recognition, regulation, and protections for LLPs vary by state. Some states don’t recognize LLPs, while others, like California, restrict their formation to licensed professionals.
Check your state laws to see if you can form an LLP.
LLC vs. LLP similarities
Pass-through taxation
The Internal Revenue Service (IRS) automatically considers LLPs and LLCs as pass-through entities. On federal income taxes, profit and losses “pass through” the business to the owners or partners, who must report them on their income tax returns.
Limited liability protection
LLCs and LLPs are responsible for their debts and liabilities. If the business faces financial trouble, owners rarely pay more than they’ve invested. For example, an owner who invested $15,000 into the company is unlikely to lose more than that.
Management flexibility
Legal agreements govern operations for LLCs and LLPs. In LLCs, this document is called an operating agreement; in LLCs, it’s called a partnership agreement. These foundational documents outline ownership responsibilities, profit distribution, and decision-making processes.
Formation and operational requirements
Both LLPs and LLCs require that owners follow the rules of incorporation. You must keep business and personal affairs strictly separate so your corporation can’t be considered an “alter ego”—in other words, another version of you that can be sued for your assets.
Stay organized by taking meeting minutes, following by-laws, and keeping up-to-date on annual filings.
What are the differences in management structures?
Management in an LLC
An LLC is flexible—run it yourself or with others, or hire a manager to handle operations, adapting management structures as you scale.
For example, say you start a business with two others. Everyone manages the online store; you lead operations, one partner oversees inventory, and the other handles finances. This is a “member-managed” structure.
As the business expands, you hire a CEO and operations director. The three owners become the board of directors, and you’re now operating under a “manager-managed” structure.
Management in an LLP
Partners in an LLP have the right to shape the business, from making decisions to signing documents and managing relationships.
LLPs are common in professional businesses, like medical practices or law firms, where each partner brings expertise and a client base.
Member-managed vs. manager-managed LLC
The main distinction between member-managed and manager-managed LLCs is how they handle daily operations and decisions.
Member-managed LLCs
- All owners run the business
- Each owner can make operational decisions and sign contracts
- Ideal for owners who work in the company
Manager-managed LLCs
- Managers handle daily operations
- Owners can focus on strategy versus daily tasks
- Useful when scaling or expanding
- Practical for passive investor-owners
Partner roles in an LLP
Partners in an LLP share equal management rights, although their roles may vary by expertise and partnership agreement.
Partner roles can include:
- Daily operations
- Specific practice areas
- Administration or management
- Business development
Decision-making processes
LLCs can set different voting powers for different members. Regardless, decisions:
- Must follow the operating agreement
- Can be formal or informal
- May require a majority vote
In an LLP, decision-making:
- Usually requires partner consensus
- Follows a formal structure
- Requires documentation
- May require executive committee participation
Voting rights and authority
An LLC’s voting rights can be proportional to ownership percentage—for example, a 40% owner gets 40% of the voting power—or be apportioned by another rationale.
LLPs often confer equal voting rights to partners. But, the entity could weigh votes based on partnership shares. Either way, the business’s foundational documents—an operating agreement for LLCs and a membership agreement for LLPs—outline the rules
LLP or LLC: Which is best for you?
If you’re planning a business with one or more partners, choosing the proper legal and management structure can optimize your tax requirements and protect your personal finances.
Consider these factors to make an informed decision about your type of corporation.
- Business activities: LLPs are suitable for professional services like law, while LLCs usually suit general small businesses.
- Ownership: Single owners need an LLC; multiple owners can choose either.
- Tax implications: LLPs only offer pass-through taxation. For more options, choose an LLC.
- Professional advice: It’s a good idea to consult your lawyer and accountant to understand which structure best suits your business.
Made your decision? Dive into the benefits of an LLP or learn how to start an LLC today.
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Differences between LLC vs. LLP FAQ
What is better: LLP or LLC?
If you are operating a professional services business, such as a law or accounting firm, a limited liability partnership (LLP) may be the better choice, since it confers personal liability protection on all partners. For owners of traditional businesses like retail stores or restaurants, an LLC offers more flexibility in taxation and management.
How does the cost of an LLP vs. an LLC differ?
Typically, LLP owners must file required documents—such as a certificate of limited liability partnership—to the secretary of state’s office, and pay fees between $40 and $1,000, depending on the state. The cost to file an LLC also differs by state. You’ll also be required to file documents to the secretary of state, and there are tax implications that increase costs, so you can expect to pay between $90 to $900.
Why would you choose an LLP over an LLC?
An LLP, or limited liability partnership, is a business structure combining elements of a partnership and a corporation. It provides partners limited liability protection and organizational flexibility.
The key advantage of an LLP over an LLC is that each partner’s personal assets are protected from the business’s debts, obligations, and liabilities. Additionally, investors appreciate LLPs for their robust liability protection. Finally, LLPs are more straightforward to administer than corporations.
What is the main difference between an LLP and an LLC?
LLPs are designed for professionals like lawyers or accountants and provide liability protection from other partners. LLCs offer a broader range of businesses general protection from debts and liabilities plus flexible management and tax options.
Always consult legal and tax professionals to determine the best entity for your circumstances.
What is the most common form of business ownership?
In the United States, sole proprietorships are the most common form of company ownership, offering the simplest and cheapest way to start a business.
