As you think about starting a new business, you may have seen confusing information on a Limited Liability Company (LLC) and a Limited Liability Partnership (LLP). These two business types may look the same at first glance but there are some key differences between LLC and LLP business types.
What’s the Same about LLCs and LLPs?
Before we look at differences here are similarities between the LLC and LLP business types, look at how they are similar.
Both business types are pass-through business types, with owners paying income tax on their share of the business profits (or losses). Although LLCs and LLPs don’t have a board of directors, these businesses must keep good business management records and have regular recorded decision-making meetings, to assure that the business is clearly separate from the owners.
Owners of both LLCs and LLPs must pay self-employment tax (Social Security/Medicare) on their income from the business each year. The fees for forming each type of business are usually similar for each state, but they also have some variation. Attorney fees for helping with the formation of the business and preparing ownership agreements depend on the size and complexity of the business and on state laws.
Each business must have an operating document that directs the decision-making process and answers what-if questions. This document includes:
- The duties and responsibilities of owners
- Day-to-day management
- What happens if an owner leaves
- How profits/losses are divided among owners
Key Differences Between LLC and LLP Businesses
Starting an LLC vs. an LLP
Businesses in the U.S. must register as a specific business type (LLC registration or LLP registration) with a specific state (except for the sole proprietorship). All states allow LLCs, but they may restrict ownership of LLPs to specific groups of professionals (accountants, attorneys, architects, etc.) with different professionals allowed in each state. California, for example, allows only groups of architects, surveyors, lawyers, public accountants, or engineers to form an LLP.
Ownership of LLCs vs. LLPs
Owners of an LLC are called members, not partners, and an LLC can have one or more members. As in other types of partnerships, LLP partners can be general partners or limited partners. General partners participate in the ownership of the business, while limited partners only invest but don’t participate in management.
One individual or several individuals can own an LLC. An LLC can also be owned by an organization, trust, non-US citizen, another LLC, or another legal entity. Only individuals can become owners of a partnership, including an LLP.
LLC vs. LLP Taxes
An LLC with more than one owner is considered a partnership for tax purposes only. This means that taxes for both LLPs and multiple-member LLCs are normally prepared using a partnership tax return.
After the net income of the partnership is calculated and reported on an information return (IRS Form 1065), the profits or losses are divided between the owners based on their percentage of ownership. Each owner receives a Schedule K-1 for his or her ownership share, to be included in the owner’s personal tax return.
Liability Protection for LLC and LLP Owners
LLC and LLP business types are set up to offer their owners protection against liability for debts of the business, and the owner’s personal liability is limited to his or her investment in the business. Limited partners in an LLP have limited liability as long as they remain passive investors (not active in running the business).
The separation of a business like an LLC or LLP from its owners creates a shield against owner liability. But this shield can be broken if the business doesn’t keep good business records or it mixes up business and personal transactions. If the liability protection shield is broken, the owners can become personally liable for debts of the business or for lawsuits against the business.
Key Advantages of LLCs and LLPs
- Business Ownership–LLCs have an advantage over LLPs because they can be owned by one or more individuals and other legal entities, while LLPs are usually restricted to specific types of owners (usually, individuals in certain types of professions, depending on the state).
- Liability protection–LLPs have an advantage if some owners want more passive ownership with no management responsibility and lower liability as limited partners. All LLC owners have the same liability protection unless an owner is a manager.
- Taxes–LLCs have the advantage of being able to be taxed as a corporation or S corporation. This ability to be taxed as a corporation can be an advantage if the business is making a profit.
Which to Choose–an LLC or LLP?
Many small businesses select the LLC form because it is flexible for ownership and tax purposes. But if you have a professional group, you might find the LLP a possibility. Take all factors into consideration.
Every business is unique, the tax situation of a business can change, and business regulations vary by state. Discuss possible business types with both your attorney and tax professional before you make any decisions.