Business partners who plan to launch a new enterprise together might consider forming either a limited liability company (LLC) or a limited liability partnership (LLP).
By default, both options are considered pass-through entities for tax purposes, and both afford liability protection to their owners. But a key difference is how liability works for the duo or group of owners. LLPs may provide some added protections for the rest of the partners if one partner is involved in misconduct.
Because rules vary widely, especially for LLPs, it’s important to research specific rules in your state. Here’s what you need to know about LLCs and LLPs.
What is an LLC?
A limited liability company is a legal management structure that is created to operate a business. Owners of an LLC, who are called members, are afforded personal liability protection, which means that their personal assets cannot be involved in the business’ litigation or debt collection. (Note, however, that this protection is contingent upon the owners keeping their personal and business finances separate.)
Individuals or multiple members can create an LLC, and there is no cap on the total number of LLC members. LLCs have choices when it comes to taxation, based on the number of members they have and the way they operate.
Single-member LLCs can choose from:
Multi-member LLCs can choose from:
- S corporation
- C corporation
What is an LLP?
A limited liability partnership is a business entity type that affords personal liability protection to business partners. LLPs are to general partnerships what LLCs are to sole proprietors—it’s a step up from the default in terms of organizational structure and liability protection. What is unique to LLPs is that partners do not assume liability for any wrongdoings of other partners, employees, or the partnership itself.
While the owners of LLCs are called members, owners of LLPs are called partners. There is no cap on the total number of partners. Typically, the responsibilities of each partner are laid out in a partnership agreement.
Professional businesses—such as law firms, accounting firms, or medical offices—often form as LLPs. State rules frequently restrict LLPs to professions that are licensed, including doctors, dentists, accountants, and lawyers, but state laws vary widely when it comes to LLPs. Be sure to check with state officials, typically in the secretary of state's office, to determine the rules where you operate.
LLC vs. LLP: similarities and differences
LLCs and LLPs have basic similarities, but they’re not synonymous.
Formation and management
- How they’re similar: Both LLCs and LLPs are legal entities that require paperwork and fees to form, including a legal agreement that spells out the details of the business’ operation—from the responsibilities of the owners to how money will be distributed and decisions made. For an LLC, this document is called the operating agreement. For LLPs, it’s called the partnership agreement.
- How they’re different: The LLC structure is available to single-owner businesses and multi-owner businesses, but the LLP is not available to single-owners. (It’s called a partnership, after all).
Members or partners
- How they’re similar: There is no cap to the number of members in an LLC or partners in an LLP.
- How they’re different: In LLPs, only individuals can be a partner. In LLCs, other business entities, including corporations, other LLCs, or trusts can be members.
- How they’re similar: LLPs and LLCs are automatically considered pass-through entities. For the purpose of federal income taxes, any profit and losses “pass through” the business to the owners, and must be reported on the LLC member or LLP partner’s personal income tax returns.
- How they’re different: LLCs have more options than LLPs when it comes to taxation. LLCs can elect to be taxed as a corporation—usually an S corporation. In an LLC without an S election (like a general partnership), members pay self-employment taxes on their portion of the LLC’s total earnings. As an S corporation, owners can elect to be paid a salary on payroll, and pay Social Security and Medicare taxes only on that salary. The rest of the business’s profits are not subject to self-employment tax.
- How they’re similar: LLC members and LLP partners can’t typically be held personally liable for the failings of the business.
- How they’re different: In many states, partners in an LLP are shielded from liability if another partner faces a malpractice claim. In LLCs, members may be held liable for other members’ malfeasance or wrongdoing. Generally, however, the LLC will insulate a member from personal liability when an employee or other member causes harm without the knowledge or direction from that member.