Wondering what are the differences between LLCs and LLPs? You’ve come to the right spot.
One of the most important decisions you’ll make when starting your business is determining its formation structure. The entity type you choose will impact your operational structures, management structures, taxation obligations, and personal liabilities as a business owner.
In this article, we’ll discuss the differences between LLPs and LLCs and guide you through how to choose one of these business entities for your company.
Let’s start with how LLPs and LLCs are defined and then dive into the differences.
LLPs and LLCs: Defined
Both LLPs and LLCs have a combination of aspects of Partnerships and Corporations. Still, there are differences between these two entities when it comes to management structures, tax benefits, and liability protections.
Before we discuss those differences, let’s take a look at what each of these business entity types actually is.
What is a Limited Liability Partnership (LLP)?
A limited liability partnership (LLP) is a general partnership formed by two or more owners (called partners). It has a combination of the aspects of a partnership and a corporation where partners enjoy limited liability protection.
All states do not allow you to form an LLP and there are different rules for formation in different states. Some states only allow a few types of professional workers such as accountants, engineers, consultants, and attorneys to form an LLP. These include New York, Nevada, and California. Additionally, the definition of LLPs varies depending on the state you’re operating in.
Before you consider the advantages and disadvantages of an LLP, you should check your state’s laws to see whether you are qualified to form one.
If your state allows, you can form an LLP by filing a certificate of limited liability partnership (or similar documents according to your state laws). You will have to create a Partnership Agreement to define the responsibilities and liabilities of each partner.
And if you’ve formed an LLP in a state and want to expand to other states, it’s important to check if that state allows that because some states don’t recognize the LLPs of other states.
What is a Limited Liability Company (LLC)?
An LLC is a business entity type that limits the liability of its owners (members). Anyone can form an LLC including individuals, corporations, consultants, foreign entities, and other LLCs. However, banks, financial institutions, and insurance companies cannot be members of an LLC.
Limited liability companies protect their members (owners) against liabilities, which means that you will not have to pay off company debts using personal assets as a member of an LLC.
To form a limited liability company, you may need to appoint a Registered Agent who will be responsible to receive all legal documents from the Secretary of State. File your Articles of organization and create an LLC Operating Agreement to define the roles and responsibilities of each member.
The Differences Between LLPs and LLCs: Management Structures
LLCs allow you to choose a management structure. You can either run a member-managed LLC (where all members actively participate in decision making) or a manager-managed LLC (where the appointed management team runs the business and other members of the LLC aren’t involved in running the business). The manager doesn’t necessarily have to be a member of the LLC too, they could be non-members as well.
On the other hand, LLPs are different. They must have a managing partner and all partners must help run the business. The roles and responsibilities defined in the Partnership Agreement specify how the company will run.
The Differences Between LLPs and LLCs: Limited Liability Protections
There’s a difference in the liability protections of the two entities as well. LLCs protect members from personal liability for business debts and lawsuits. A creditor can’t sue LLC owners or capture their personal assets such as homes, personal bank accounts, and cars to recover debts. That said, if you or any other member of the LLC commits any act that is legally actionable, then the members and the LLC can both be held liable for it.
If you form an LLP, each partner will be personally responsible for their own negligence. They are not liable for the mistakes of another partner, which is a major difference between LLCs and LLPs. These partners only risk their capital in the LLP.
In some states, LLP partners are personally liable for partnership debts so it’s important to check with your state to see all rules and regulations thoroughly.
The Differences Between LLPs and LLCs: Tax Benefits
By default, LLCs don’t pay income taxes. They offer pass-through taxation, which means that company profits and losses are passed through to each member, who then needs to report them on their individual income tax returns.
That said, both LLCs and LLPs are required to file an informational tax return, and there’s no difference between the two there.
LLCs can choose to get taxed as a Sole Proprietorship, Partnership, or Corporation.
If you have a single-member LLC, you will be taxed as a Sole Proprietorship and you will also have to pay self-employment taxes. Some LLCs, though, are required by the federal tax laws to be taxed as Corporations.
LLPs also allow pass-through taxation, which means that partners need to report the profits and losses of the company on their personal federal income tax returns.
Some states do not allow pass-through taxation for LLPs and impose a state franchise tax instead.
Pros and Cons of an LLC vs LLP
Here are the advantages and disadvantages of LLC and LLP over each other based on their differences.
Pros of LLCs
- A single member can also form an LLC
- It protects the members from the business’s debts and provides privacy for the members’ personal information too
- Gives good flexibility in terms of taxation
Cons of LLCs
- Requires you to pay annual fees
- Some states don’t allow LLCs for some professions
Pros of LLPs
- Protection from the negligence of other business partners
- Easy to set up
- Give flexibility in the business management structure
Cons of LLPs
- Aren’t recognized in every state like LLCs are
- May be restricted to certain professions in a few states
FAQs
1. What is the advantage of an LLP over an LLC?
LLPs offer protection for partners from the negligence of other partners. You’re only held liable for the mistakes you make and that’s a major difference between the two. It may cost less to run an LLP than an LLC.
Many professional businesses prefer forming a limited liability partnership to protect their personal liabilities while partnering with individuals from a similar profession.
2. What is the difference between LLC and LLP?
The differences between LLCs and LLPs include:
- LLCs may have one or more members but LLPs must have at least two partners.
- Filing requirements are more complicated for forming a limited liability partnership than a limited liability company.
- Most states allow you to form an LLC but not all states allow you to form an LLP.
- Only people from certain professions can form an LLP whereas anyone can form an LLC except banks and insurance companies.
- There’s a difference in costs of running both. It can cost more to run an LLC than an LLP.
3. Is forming an LLP a good idea?
Forming an LLP is a good idea if you want to form a professional partnership that offers liability protection. This business structure is particularly suited for attorneys, architects, accountants, consultants, and engineers.
You should check with your state to see if it allows you to form an LLP and also go through all rules and regulations that you will need to follow. Many states don’t offer pass-through taxation to LLPs and impose a state franchise tax.
4. Is an LLP a Partnership or an LLC?
An LLP is a hybrid business structure with aspects of both a partnership and a corporation. It’s different from an LLC.
5. What are the disadvantages of forming an LLP?
The disadvantages of forming an LLP include:
- Not all states allow the formation of an LLP.
- Only individuals of specific professions such as attorneys, architects, accountants, consultants, and engineers can be partners of an LLP.
- LLPs must have at least two partners.
- LLPs must have a managing partner but all partners should help run the business.
- LLPs have more complicated filing requirements.
- Not all states allow pass-through taxation for limited liability partnerships.
Are You Ready to Choose Between an LLP or an LLC?
Before you register your new business, you should understand the full implications of each of these entity types. Also, every state has different rules and criteria for forming LLCs and LLPs. You should check with your state to learn about state laws or you can also hire a law firm.
Now that you understand what forming a limited liability partnership (LLP) and a limited liability company (LLC) mean and their differences, you can pick the one that best meets your business needs.
However, you need to complete all of the paperwork and filing processes correctly for forming both an LLC and an LLP.
Do you need help forming an LLC or an LLP? Connect with our experts for advice and get started with your business formation process today.
Regardless of the structure you choose, we have got you covered.