How to Form a Limited Liability Partnership
What Is an LLP?
Partnerships come in several different types, but all have some common characteristics. A limited liability partnership (LLP) is a specific type of partnership that combines the advantages of corporate and partnership forms of business.
It's most commonly used by professionals such as doctors, attorneys, and accountants who go into practice together.
What Is a Partnership?
All partnerships consist of individuals who have agreed to run a business together under the terms of a partnership agreement. Each partner has invested in the business.
The partnership is a separate legal entity from the partners, but the partners have liability for the actions of the partnership in most cases. This arrangement differs from a corporation, which is separate from its owners with regard to liability.
Partners are not employees. They take money from the business as distributive shares, not as salaries.
All types of partnerships pay income taxes by filing an information tax return on IRS Form 1065, with individual partner shares of the income or losses of the partnership reported on a Schedule K-1. Partners then report their shares of income on their federal personal returns, although not all states allow this type of "pass-through" taxation at the state level.
An LLP is not taxed twice, once at the business level and again at the personal level, the way a C corporation is.
Limited Liability Partnerships vs. Other Partnerships
An LLP combines characteristics of partnerships and corporations, particularly in the area of limited liability. A partnership typically doesn't provide its individual partners with limited liability from lawsuits and debts. But all partners have limited liability from errors, omissions, negligence, incompetence, or malpractice committed by other partners or by employees in the LLP form, just as in a corporation.
Any partners involved in wrongful or negligent acts are still personally liable, but other partners are protected from liability for acts committed by another.
Many professionals form LLPs because it protects them from being involved in a malpractice lawsuit against another partner, at least to some degree.
Limited Liability Partnership vs. LLCs
The most obvious difference between an LLP and a limited liability company (LLC) is that the owners of an LLP are partners. The owners of an LLC are referred to as "members."
Liability of owners is the biggest difference between an LLP and an LLC. Partners in an LLP are not typically liable for the debts or negligent acts of other partners, whereas liability of members of an LLC is limited to each member's contribution. It doesn't consider the liability of other members or of the LLC as a whole.
This protection is called a "corporate shield" or sometimes a "corporate veil."
Wrongdoing or negligence outside the scope of the owner's duties doesn't have liability protection in either type of business. Some examples would be if an owner sexually harasses an employee or client, steals from the company, or physically assaults someone.
LLC members can decide between member management and hired management, while partners in an LLP manage the partnership themselves. All partners have the same general management responsibilities in an LLP. The flexibility of management isn't the same as with an LLC because an LLP is a partnership.
An LLC has several tax options. It can be taxed as a corporation or as an S corporation. An LLP can only be taxed as a partnership.
LLPs vs. Limited Partnerships
Don't confuse an LLP with a limited partnership. A limited partnership is a type of partnership with both general partners and limited partners.
How to Form a Limited Liability Partnership
A limited liability partnership is formed in the state in which the partnership does business. Most states have a business filings section in their office of the Secretary of State or an equivalent department.
The partnership must register specifically as an LLP, filing a form as a "limited liability partnership" or a similar type of declaration. The partnership should also create a partnership agreement to spell out how the partnership will be run and what happens in various circumstances.
Most states allow all professionals to form LLPs, but a few states limit the ability to form an LLP to just accountants and attorneys.
Not all states recognize "foreign LLPs," those that are formed in other states. These states might treat your LLP as a general partnership instead, which can affect issues of liability there.