Differences and How to Choose (2024)

Differences and How to Choose (2024)


Business partners who plan on starting a business together might consider forming either a limited liability company (LLC) or a limited liability partnership (LLP).

When it comes to LLC vs. LLP, there are a few key differences. Although both are granted limited liability protection and don’t directly pay income taxes, they differ in management requirements, liability protections, liability insurance obligations, and tax benefits.

As requirements vary from state to state, it’s impossible to give a catchall summary of what all the differences entail, so researching through your local enterprise office is the best way to understand how LLCs and LLPs differ.

Here’s what you need to know as a business owner about LLCs and LLPs.

What is an LLP?

A limited liability partnership is a business entity type that affords personal liability protection to business partners. 

Professional businesses—such as law firms, accounting firms, or medical offices—often form as LLPs. State rules frequently restrict LLPs to professions that are licensed, including doctors, dentists, accountants, and lawyers, but state laws vary widely when it comes to LLPs. 

Be sure to check with state officials, typically in the secretary of state’s office, to determine the rules where you operate.

Advantages

As a hybrid business structure, LLPs offer several advantages:

  • Partners are not personally responsible for the debts of the business or their partners’ actions.
  • An LLP can buy, rent, lease, or own property, or enter into contracts, as it’s considered a person.
  • Two companies can be the owner of an LLP, versus a limited company, where there must be one real person.
  • Partners can distribute profits as determined by a partners agreement. 
  • It’s less expensive to form an LLP versus forming a corporation. 

Disadvantages

  • LLPs are not allowed in every state, and each state regulates them differently. For example, in Nevada, only certain licensed professionals can operate as an LLP. 
  • Many jurisdictions require LLPs to file annual reports and other details with a public registry, including information on profits, losses, and partner income.
  • LLPs must have two members at all times. If one member decides to leave, the entity will be dissolved. 
  • LLPs are considered pass-through entities and all taxes are paid individually. 

What is an LLC?

LLCs are popular business structures in the United States because they give you the liability protection of a corporation and the flexibility of a partnership or sole proprietorship. 

“LLCs are commonly used for small to medium sized businesses,” says Justyna Mueller, partner at James Moore Certified Public Accountants and Consultants. “The interesting thing about them is that the US has no tax code for them. LLCs need to choose how they want to be taxed.”

An LLC can choose to be taxed as a C corporation or as a pass-through entity. “As a pass-through entity, you’re required to file a tax return, but the entity itself doesn’t pay any tax. Instead, the income it makes is recorded on the owners’ individual income tax return,” Justyna adds. “LLCs are easier to manage because they have fewer state-imposed requirements for running your business.”

Advantages

  • If an LLC goes bankrupt or is sued, the members’ personal assets (i.e., houses, cars, and bank accounts) are protected.
  • An LLC is easy to form, cost-effective, and doesn’t require annual shareholder meetings or a lot of paperwork.
  • An LLC allows you to choose between different tax classifications to optimize your tax liability, including pass-through taxation to avoid double taxation.
  • With LLCs, you can have any number of members, without citizenship requirements, and you can adjust ownership percentages easily.
  • Unlike partnerships, members can divide profits based on contributions or agreed terms.
  • LLCs don’t require public disclosure of ownership details, so they’re great for investors who want anonymity.

Disadvantages

  • Personal liability protection doesn’t apply to fraud or corporate malfeasance.
  • You may owe self-employment taxes while corporate taxes are usually waived.
  • Renewal fees might be higher. For example, Delaware charges $110 for the initial charter, $75 to get a business license, and a $300 yearly fee for filing an annual report. 

LLC laws vary from state to state. For guidance on how to start an LLC in your state, check out our state-specific guides:

LLC vs. LLP differences

LLCs and LLPs have basic similarities, but they’re not synonymous.

LLC LLP
Formation Suitable for single or multi-owner. Only for multi-owner businesses.
Management Member-managed or manager-managed. Managed by partners.
Ownership Can be owned by individuals, entities, or foreigners. Owned by licensed professionals.
Taxation Pass-through, but can opt for corporation. Default as pass-through entity.
Liability Protection Limited personal liability; exceptions apply. Limited personal liability; shields from partners.
Existence Generally perpetual. Duration defined, may need renewal.

Formation

The LLC structure is available to single-owner businesses and multi-owner businesses, but the LLP structure is not available to single-owners. (It’s called a partnership, after all).

Management

Both LLCs and LLPs are legal entities. LLC’s can be managed by members (member-managed) or by managers appointed by the members (manager-managed). LLPs are managed by the partners, although some may take on more managerial roles than others.

Ownership

LLCs offer a wide range of flexibility in terms of who can own and how ownership and voting rights are determined. For example, an LLC can be owned by individuals, corporations, trusts, or foreign entities. 

In general, LLPs are more rigid. In many states, LLPs can only be formed by licensed professionals in specific industries. Lawyers, accountants, doctors, and architects use them a lot. 

Taxation

LLCs have more options than LLPs when it comes to taxation. LLCs can elect to be taxed as a corporation—usually an S corporation. In an LLC without an S election (like a general partnership), members pay self-employment taxes on their portion of the LLC’s total earnings. 

As an S corporation, owners can elect to be paid a salary on payroll and pay Social Security and Medicare taxes on only that salary. The rest of the business’s profits are not subject to self-employment tax.

Liability protection

LLC members and LLP partners typically can’t be held personally liable for the failings of the business.

In many states, partners in an LLP are shielded from liability if another partner faces a malpractice claim. In LLCs, members may be held liable for other members’ malfeasance or wrongdoing. Generally, however, the LLC will insulate a member from personal liability when an employee or other member causes harm without the knowledge of or direction from that member.

Existence

The majority of states in the US allow LLCs to have a perpetual existence, meaning they can keep going indefinitely. The duration of an LLP can be set for a specific number of years, after which it must either be renewed or dissolved.

States differences

The recognition and regulation of LLPs vary by state. Some states do not even recognize LLPs as an entity, or have specific restrictions on their formation and operation. They also have various degrees of protection, depending on where the LLP was filed. 

Some states, like California, allow only licensed professionals (like accountants or lawyers) to form an LLP. States like Texas allow any group to form an LLP. Check your state laws to see if you’re eligible to form an LLP. 

LLP vs. LLC similarities

Pass-through taxation

LLPs and LLCs are automatically considered pass-through entities by the Internal Revenue Service (IRS). For the purpose of federal income taxes, any profit and losses “pass through” the business to the owners, and must be reported on the LLC member’s or LLP partner’s personal income tax returns.

Limited liability protection

LLCs and LLPs are both responsible for their own debts and liabilities. If the business is unable to pay what it owes, the owners’ personal assets are often protected. Say, for example, an owner invested $15,000 into the company; they’d only lose, at most, their $15,000 investment. 

Management flexibility

Both LLCs and LLPs require a legal agreement to spell out the details of the business’s operation—from the responsibilities of the owners to how money will be distributed and decisions made. For an LLC, this document is called the operating agreement. For LLPs, it’s called the partnership agreement.

Formation and operational requirements 

Both LLP and LLCs require you to follow the rules of incorporation. You must keep business affairs separate from personal affairs or your corporation can be considered a sham. Lawyers could go after your personal assets based on “alter ego theory,” which is where the entity is not separate from the owner, but just their alter ego. 

You must also keep up with the applicable corporate documents, like by-laws and meeting minutes. The company must also stay current on its annual filings with the state. 

LLP or LLC: Which is best for you?

If you’re thinking of starting a business with a partner (or many partners), the right legal and management structure can reduce your tax burden and protect your personal finances. 

Here’s what to consider to make an informed decision about your type of corporation. 

  • Nature of your business: For professional services (like law or accounting), consider an LLP. For a general small business, go with an LLC.
  • Ownership: Single owners need an LLC, multiple owners can choose either. 
  • Tax implications: LLPs offer only pass-through taxation. If you want more tax options, lean toward an LLC. 
  • Consult a professional: Get insights from a lawyer and accountant for tax implications.

Once you’ve decided, you’re ready to go. If you’re not interested in forming an LLP, learn how to start your LLC today. 

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Differences between LLC vs. LLP FAQ

What is better LLP or LLC?

It depends on your business needs. A limited liability partnership (LLP) may be a better choice if you are operating a professional services business, such as a law or accounting firm. This type of structure offers personal liability protection to all partners. An LLC may be a better choice if you are operating a traditional business, such as a retail store or restaurant, as it offers more flexibility in taxation and management.

How does the cost of an LLP vs. an LLC differ from each other?

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.

Why would you choose an LLP over an LLC?

An LLP (limited liability partnership) is a business structure that combines elements of both a partnership and a corporation. It allows partners to enjoy limited liability protection while still having the flexibility of a partnership.

The key advantage of an LLP over an LLC is that, with an LLP, each partner’s personal assets are protected from debts, obligations, and liabilities of the business. This means that if something goes wrong with the business, the personal assets of each partner are protected. Additionally, LLPs are more attractive to investors due to the increased liability protection. Furthermore, LLPs typically are simpler to administer than corporations.

What is the main difference between an LLP and an LLC?

LLPs are designed for professionals like lawyers or accountants and provide liability protection from other partners. LLCs offer general protection from business debts and liabilities for a broader range of businesses.

In contrast to LLPs, LLCs offer more management flexibility and tax options. Always consult with legal and tax professionals to determine the best entity for your specific circumstances.

What is the downside of an LLP?

The main downside of an LLP is that the members of the LLP have unlimited personal liability for the debts and obligations of the LLP. This means that each member is responsible for the liabilities of the LLP, regardless of their individual contribution.

This can leave members exposed to potential personal financial losses and is a major consideration when deciding whether or not to form an LLP. Additionally, LLPs are subject to more stringent regulations than other business structures, such as sole proprietorships or corporations, which can increase administrative costs.



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