Anybody can agree to run a business together—just like anyone can agree to get married. But actually doing the thing—navigating the complexities and challenges of building and running a business venture—is something else altogether.
A limited liability partnership can help set you and your partner(s) on the path to success with liability protections in case the business, or one of you, missteps, along with simpler taxes and the ability to add new partners to help grow your business.
What is an LLP?
An LLP, or limited liability partnership, is a business entity type that affords personal liability protection to business partners. What is unique to LLPs is that partners do not assume liability for any wrongdoings of other partners, employees, or the partnership itself.
This protection is why the LLP business structure is popular with lawyers, accountants, doctors, dentists, architects, and other professionals who typically require a license to operate (and who could potentially lose their license if convicted of malpractice). In some states, LLPs are limited to professional businesses that require a license.
What are the benefits of forming an LLP?
LLPs come with a few tax and liability benefits for business owners. Here is an overview of the benefits of forming an LLP:
- Liability protection. LLPs typically shield partners from personal liability for the failure of one of their partners and, potentially, the entire business, but these protections vary by state. State rules also change from time to time. It’s best to check the local rules where you operate to understand what might apply to your business.
- Taxation. Because an LLP is considered a pass-through entity, LLP members simply include any profits and losses from the partnership on their personal tax returns.
- Low barrier for formation. In most states, forming an LLP is a straightforward process involving some paperwork and fees. Typically, LLP owners need to fill out documents required by the secretary of state’s office, such as a certificate of limited liability partnership, and pay a fee, which can be between $40 and $1,000, depending on the state. Most states also mandate annual reporting to ensure that the LLP stays up to date on any compliance requirements. Annual reporting requirements vary by state but typically include basic information, like the number of partners in your LLP and their names, your business address, and the registered name of the LLP.
- Flexible to evolve over time. New partners can join and longtime members can move on without disruption to the core business, as long as the partnership agreement allows it.
Difference between an LLP and a general partnership
LLPs are different from general partnerships, in which partners are personally exposed if the business faces legal action due to the wrongdoings of another partner. General partners may be required to cover business debts or legal claims with their own personal assets, which include personal savings and property, such as houses or cars. Sole proprietors face a similar risk.
The legal structure of an LLP shields the partners’ personal assets from being seized if another partner is convicted of malpractice or fraud.
Difference between an LLP and a limited partnership
A third kind of partnership—a limited partnership—is different from both a general partnership and an LLP. In limited partnerships, there are two types of partners: general and limited. A general partner is in charge of the business’ daily affairs, while the limited partner simply supports it financially. Limited partners can’t be held liable for business debts, as long as they don’t take an active role in the organization’s operations. A general partner, however, could lose their personal assets to cover business debts or legal obligations.
All partners in an LLP may enjoy the advantage of at least some limited liability. LLPs also do not have a hierarchy of general versus limited partners, as in a limited partnership. Instead, partners can mold the leadership and management structure of the LLP to meet their specific needs. Roles and responsibilities among partners are laid out in the partnership agreement.
Key differences between LLP and LLC
Partnerships aren’t the only legal entities available to a group of business partners. Limited liability companies, or LLCs, are another popular option, but there are several important differences between LLPs and LLCs.
- How they’re similar: Both LLCs and LLPs protect their owners from personal liability in the case of litigation or business debt.
- How they’re different: LLPs take liability protection a step further and protect individual partners from liability for the torts (or illegal acts that could lead to a lawsuit) of other partners, employees, or the partnership itself.
Ownership and eligibility
- How they’re similar: LLCs and LLPs are both generally available to groups of people wanting to form a business together. There are no caps on the number of owners (called “members” in an LLC and “partners” in an LLP) in either structure.
- How they’re different: Rules vary by state about who can create an LLC or an LLP. Some states restrict LLPs to specific professionals, such as lawyers or accountants, who require a license to operate. In some states, such as California, those professionals are not allowed to operate as an LLC. Check with the appropriate state agency, usually the secretary of state, to find out what’s allowed where you operate.
- How they’re similar: Both LLCs and LLPs are considered pass-through entities. For tax purposes, any money earned through the business is considered the owners’ personal income.
- How they’re different: LLCs can elect to be treated as a corporation—usually an S corporation—to reduce their self-employment tax burden. LLPs don’t have this option. Most state tax agencies also mandate that LLPs report annually to ensure they are up to date on compliance requirements. Annual reporting requirements vary by state but typically include basic information such as the number of partners in your LLP and their names, your business address, and the registered name of the LLP.
When considering how to structure your new business partnership, here are some questions for you and your business partners to work through via research and potential consultation with an attorney:
- Are we licensed professionals?
- What entity types are allowed to provide professional services in our state?
- What eligibility rules does our state have about LLPs?
- What individual protections does our state afford partners in an LLP?
- What annual reporting requirements are in place in our state? Are we equipped to meet them?
- What insurance policies does our state require us to carry, both individually and as a business, if we organize as an LLP?
- Do we want pass-through taxation, or do we want to be taxed as a corporation?