Difference between limited liability company and limited liability partnership

One of the major decisions you will take on as you start up your business is what type of business entity to select. There are pros and cons to every type. Understanding your options is the first step in making an educated decision about this important step in the business formation process.

What Is the Difference Between an LLC and an LLP?

An LLC is a limited liability company and an LLP is a limited liability partnership Both are legal business entities. Both provide the benefit of limiting the liability of partners or members involved in the business. Both are not viewed as “businesses” by the IRS for taxation purposes. This means that, while tax documents must be submitted to the IRS for the business, the LLC or LLP itself does not directly pay income taxes. The business earnings pass directly to the partners or members. Each individual partner or member must then report earnings on his or her personal tax forms. This is why both an LLP and LLC is referred to as a “pass through” business entity. Corporate taxes are avoided and “passed through” to personal income taxes instead.

While there are similarities between LLCs and LLPs, there are some key differences. First of all, every state allows for the formation of an LLC. Only around 40 states, Texas included, allow for the formation of an LLP. The majority of LLPs are professional businesses. LLCs include businesses of all kinds. One of the biggest differences between an LLP and an LLC, however, is how the entities are managed.

With an LLC, there are two options for how it can be managed. It may be under member management where the individual members manage the entity directly. It can also be under manager management where the LLC can hire outside management or appoint a member or non-member to manage the business. On the other side of things is an LLP which is run in a way similar to a partnership. Essentially, the business partners carry equal responsibility for the management of the business. Unlike an LLC, an LLP must have a managing partner which is liable for the actions of the partnerships. Partners and investors who do not assume a managerial role receive the benefit of liability protection.

Liability protection is also a big difference between an LLC and an LLP. While both allow for limited liability for all members and partners, these protections are different with each entity. An LLC offers personal liability protection from any debts or lawsuits filed against the business for all individual members. With an LLP, partners are personally liable, but only for their own negligence. This means that one partners is not held responsible for the actions of another partner. Each partner has liability protection form wrongs committed by another partner. Also, the liability will only involve that particular partner’s direct financial investment in the LLP.

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Learn the distinctions between a limited liability company (LLC) and a limited liability partnership (LLP) before deciding on a business structure.

As you start your new business venture, you may explore different business entities to limit your personal liability. Two options are a limited liability company (LLC) and a limited liability partnership (LLP). Both are simple to set up, but may not be an option for every business in every state.

What Is an LLC?

A limited liability company (LLC) is a separate business entity with one or more owners, known as members. You may create an LLC by filing the appropriate paperwork with your secretary of state. This typically includes filing articles of incorporation, paying a filing fee, and creating an operating agreement. When properly formed, the business is a separate entity from its owners, meaning the LLC owns business property, bank account, and has its own tax identification number.

What Is an LLP?

A limited liability partnership (LLP) is essentially a general partnership with the addition of limited liability for one or more partners. A general partnership is formed whenever two or more people do business together and does not require any legal filings. To create an LLP, you must file additional paperwork with the state. Like an LLC, an LLP is a separate business entity.

Comparing LLCs and LLPs

Take time to weigh the pros and cons of these two different business structures before forming your business.

Liability Protection

Both an LLC and an LLP provide some protection against personal liability, reducing each partner's or member's liability to the amount they invested in the business. Generally speaking, an LLC provides the most liability protection. Except for cases of business mismanagement, the members are not personally responsible if the LLC is sued or owes any debt. This serves to protect personal assets like members' houses, bank accounts, and cars.

After formed, the partners of an LLP may have limited liability like an LLC, but this depends on the state where you filed. In some states, an LLP only provides protection from being responsible for another partner's negligent acts, but the partners remain personally responsible for the overall debts and obligations of the business. Further, some states require at least one partner to have unlimited personal liability, while other partners are protected.

Taxation of LLCs and LLPs

An LLC can opt to be taxed as a sole proprietorship, partnership, or corporation. In contrast, an LLP must file as a partnership. Filing as a sole proprietor or a partnership means that the income is passed through the business, and the taxes are paid only once as income of the individual. If filed as a corporation, the business first pays tax on its corporate tax return, and the same income is taxed a second time on the personal tax return.

In addition, both LLCs and LLPs can take advantage of the 20% pass-through deduction. This means you can deduct up to 20% of your business profits from your personal tax return. There are some limitations on this complex tax break.

Management Structure: Operating Agreement vs. Partnership Agreement

Another difference between the two entities is the process for determining the management structure. As mentioned, an LLC may have only one member, while an LLP must have at least two partners. An LLC is managed according to its operating agreement which is created by the members. This document outlines the financial contributions made by each member, how profits will be distributed, and who is responsible for management decisions.

You may opt to have a member-managed LLC, meaning that all the owners have a say in how the business is run. Alternatively, you may create a manager-managed LLC, where you have passive owners or investors who are not involved in the decision making for the company.

With an LLP, the management structure is determined by the partnership agreement. Like the operating agreement, the partnership agreement details the roles of each partner, their financial contributions, and profit distributions. Here you have the option to specify that one partner is a "silent partner," meaning that, like in a management-managed LLC, they will receive a share of proceeds but will not participate in decision making for the business.

Choosing the Best Option for You: LLP or LLC

Take time to weigh the pros and cons of each business structure. It is challenging, as well as costly and time-consuming, to change the business structure after you have made the state filings. Overall, if your main concern is limiting liability or tax flexibility, an LLC is probably your best option. However, take a look at your state tax laws; some states may impose a higher tax on LLCs than LLPs.

In some cases, the decision may be made for you based on the state where you want to file and the type of business. If you are running the business on your own without partners, you cannot form an LLP. Additionally, not every state recognizes LLPs as a business structure. Some states only allow professional businesses, like accounting firms and law offices, to use LLPs. Similarly, some professionals may not be allowed to form an LLC, and must go with an alternate structure like an LLP for protection.

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