When you’re starting a small business that has more than one owner, you and your partner(s) may have concerns about your personal liability risks. If this is the case, it would be wise to compare LLP vs. LLC business structures.
Limited liability partnerships (LLP) and limited liability companies (LLC) combine some aspects of general partnerships and corporations. As sorts of hybrid entity types, they provide a level of liability peace of mind for their owners while preserving some of the simplicity of operating as a general partnership. Although they have some things in common, they also have some notable differences entrepreneurs should assess when deciding on the ideal business entity for their companies.
In this article, we’ll dig into some of the key similarities and differences between the LLP and LLC. Keep in mind, the business structure you choose will have both short- and long-term effects, so it’s important to weigh the pros and cons and discuss them with your attorney, accountant, and tax advisor.
An Overview of LLP vs. LLC
A limited liability partnership (LLP) is, in many ways, similar to a general partnership. There must be at least two partners to form an LLP. However, unlike a general partnership, an LLP is a separate business entity from its owners and its partners receive liability protection. Also, states require official formation paperwork to form an LLP. In contrast, a general partnership is created automatically, without a legal registration filing, whenever two or more people do business together.
A limited liability company (LLC) is an official business entity that may be formed by one or more business owners (called members). In terms of having more than one owner, a multi-member LLC is the equivalent of an LLP. An LLC is a separate legal entity from its owners. Therefore, an LLC’s members receive some degree of personal liability protection. States require registration paperwork to be filed with their secretary of state (or comparable agency) office to form an LLC.
How Do They Compare?
In the debate of LLP vs LLC, it is important to consider the similarities and differences between the two entity types. These key areas to review include ownership, liability, taxes, and management.
Ownership
LLP Ownership
A limited liability partnership has two or more owners (partners). Generally, there is no cap on the number of owners an LLP may have. All of an LLP’s partners are involved in the management of the business (similar to partners in a general partnership), with the added benefit of limited personal liability. The state’s statutes where an LLP is formed set forth who may be a partner in an LLP. There’s usually a good deal of flexibility, allowing individuals, other partnerships, corporations, and other entities to become partners. There may be some restrictions, however, depending on a state’s laws. For example, in California, only licensed lawyers, architects, and accountants may form an LLP. This is important to mention because if an LLP in one state expands to another state, the state to which it expanded may not recognize the company as an LLP if the company doesn’t meet its definition of what an LLP must be. Therefore, the company may be treated as a general partnership (no liability protection for owners) in the additional state.
To ensure that the percentage of ownership, roles, and responsibilities of all partners is documented, an LLP should have a written partnership agreement in place.
LLC Ownership
A limited liability company can have one or more owners (members), which can include individuals, other LLCs, corporations, or foreign entities. As with an LLP, typically, there are no restrictions on the number of members an LLC may have. Depending on the state’s rules, some types of business may be prohibited from forming an LLC. For example, typically, companies in the insurance and banking industries are not allowed to register as an LLC. And some states prohibit some types of licensed professionals (such as doctors, attorneys, accountants, and architects) from operating as an LLC—however, there is typically the option to form a professional limited liability company (PLLC) as an alternative.
To ensure that the percentage of ownership, roles, and responsibilities of all members is documented, an LLC should have a written LLC operating agreement in place.
Liability
LLP Liability
As with most aspects of the LLP entity, the degree of liability protection partners receive depends on the state’s laws.
An LLP is a separate legal entity from its owners. Therefore, an LLP partners’ personal liability for legal and financial debts of the business is usually limited to their capital contributions to the business. Generally, their personal assets (house, car, retirement funds, etc.) are not at risk of being taken in the event of lawsuits against the LLP or financial issues that the company faces. However, note that LLP partners are responsible for their own acts of negligence and mistakes, including failure to carry out reasonable care in supervising employees’ activities or other parties involved in their business. Some LLPs (particularly those in certain professions) may be required to carry liability insurance or have an escrow account to cover liabilities for which the LLP’s partners do not bear personal liability.
LLC Liability
A limited liability company’s members are protected from personal liability for business debts and claims because the business is considered a separate legal entity from its owners. As with an LLP, the degree of protection may vary from one state to the next.
Usually, if a creditor or someone else sues the business, the LLC members are typically not held personally responsible. Therefore, the owners may lose their monetary investment in the business, but their personal assets won’t be at risk. If an LLC member injures someone, does something fraudulent, personally guarantees a bank loan or debt on which the company defaults, or otherwise doesn’t act legally or keep personal affairs separate from the business, their liability protection may be denied by a court.
Income Taxes
LLP Taxes
Although an LLP is a separate legal entity, it is considered the same tax-paying entity as its owners. At tax time, the LLP files an annual information return to report the income, deductions, gains, losses, etc. from its operations, and the LLP’s partners each report their share of the business’s profits and losses on their individual tax returns. All tax payment obligations (including income and self-employment taxes) pass through to the LLP’s owners—the LLP entity does not pay income taxes.
LLC Taxes
By default, an LLC with two or more members is taxed like a partnership. So, the tax treatment described above for an LLP applies to a multi-member LLC. However, an LLC has some tax flexibility that an LLP does not. It may elect to be taxed as an S Corporation or C Corporation.
By electing S Corp tax treatment, LLC members still have pass-through taxation but with the benefit of a reduced self-employment tax burden. As an S Corp, members only pay Social Security and Medicare taxes on their income taken as salaries. Income taken as distributions (dividend income) is not subject to self-employment taxes.
If an LLC’s members opt for the company to be taxed as a corporation, business profits are taxed at the corporate rate. In this scenario, the LLC first pays tax on its corporate tax return, and then most of that income is taxed a second time on the members’ personal tax returns.
Note that income tax may be handled a bit differently at the state level for LLPs and LLCs. Also, some states have another tax called a franchise tax or annual tax that LLCs and LLPs are subject to.
Management
LLP Management
In an LLP, the business owners enjoy flexibility in their management roles. They may choose to give authority and responsibilities to partners based on each individual’s financial investment in the company or according to their expertise and professional strengths.
An LLP should have a partnership agreement that describes:
- Each partner’s financial investment in the business
- Allocation of profits and losses
- Each partner’s rights, roles, and responsibilities
- How decisions should be made
- Provisions for taking profits out of the company
- How disputes among partners should be resolved
- Other important details of how the LLP should be operated
A written partnership agreement, created with the assistance of an attorney, can help keep all owners on the same page regarding who is responsible for what and guide them in how to address any disagreements between partners.
LLC Management
An LLC may be managed by its owners (member-managed LLC) or by one or more managers (manager-managed LLC). How an LLC is managed is defined by its LLC operating agreement. An LLC operating agreement, created with the help of an attorney, can help ensure that all members understand how the LLC should be run.
Some of the information that may be found in an LLC operating agreement includes:
- Each member’s financial investment in the business
- How profits and losses should be distributed
- Each member’s and manager’s rights, roles, and responsibilities
- How decisions should be made
- How disputes among members should be resolved
- What happens if a member wants to leave the business or dies
- Other important details of how the LLC should be operated
Starting an LLP or LLC
1. Business Formation Paperwork
LLP Formation
To form an LLP, partners must file the state’s required business registration paperwork and pay any associated filing fees. As I mentioned earlier, an LLP should also have a written partnership agreement. Although states usually don’t ask LLPs to file their partnership agreement with the Secretary of State office, they may require that it be kept at the LLP’s principal place of business. In some states, such as New York, LLPs are required to publish a copy of their Certificate of Registration or a notice of their formation in one or more newspapers or other publications.
LLC Formation
To form an LLC, members must file Articles of Organization (sometimes called Certificate of Organization) with the state and pay the associated filing fees. The LLC should have an LLC operating agreement at its principal location. Usually, states do not require that an LLC file its operating agreement with the Secretary of State office. Although not required by all, some states (such as New York) require that LLCs publish a notice in newspapers to inform the public of the LLC’s formation and ownership.
2. Business Name Registration
When an LLP or LLC submits its formation documents, its name will automatically become registered with the state. As such, no other registered business entity that provides the same or very similar products or services may be granted the right to use that name.
Some states (such as North Dakota) require that if a limited liability partnership uses a fictitious name—a name that doesn’t include the last names of the partners in it—it must file a DBA. It’s critical to research the state’s naming requirements for an entity type before using the name in any formation filings or other documentation.
Also, it’s vital for partners of an LLP or members of an LLC to do a corporate name search before filing their formation paperwork. That will enable them to identify if their desired business name is available before they spend money to register the name with the state.
If an LLP’s or LLC’s owners wish to expand their business beyond their state, I suggest also doing a trademark search to see if the name is available for registration through the United States Trademark and Patent Office (USPTO).
Businesses operating as limited liability partnerships must display “LLP” at the end of their name. Those that operate as limited liability companies must display “LLC” at the end of their name.
3. Registered Agent
LLPs and LLCs must designate and retain a registered agent. A registered agent (sometimes called a resident agent) is a company or individual that resides in and is recognized by the state as authorized to accept service of process on behalf of a business. Examples of the types of documentation a registered agent receives for companies include:
- Subpoenas for information
- Notices of lawsuits
- Official state and federal correspondence
- Court summonses
- Corporate filing notifications
Some state websites list authorized registered agents in their jurisdictions. An attorney might also provide recommendations. I encourage business owners to consider designating a registered agent that is authorized to provide its services in all 50 states (like CorpNet). That way, if the business expands beyond its borders, it already has a reliable resource to rely on, no matter where its operations are.
4. Business Licenses and Permits
Depending on the type of business and location, LLCs and LLPs may have to secure licenses and permits to operate legally. Licensing and permitting may be required at the federal, state, or local level.
Examples of possible licensing and permitting requirements include:
- Tax permits
- General business licenses
- Health permits
- Zoning and land-use permits
- Professional licenses
Through CorpNet’s Business License Service Packages, LLPs and LLCs can have us help identify the specific requirements, prepare the applications, or even obtain all of the required licenses and permits for their company.
5. EIN
Both LLCs and LLPs must obtain a Federal Tax ID Number (a.k.a. EIN, Employer Identification Number) from the IRS. An EIN is a nine-digit ID number used for tax filings and on other business paperwork (such as opening a business bank account). It helps to draw the line of separation between the business and its owners. Ordering an EIN from the IRS is rather simple; to save time, an LLP or LLC can have CorpNet prepare and submit the form to the IRS on its behalf.
6. Ongoing Business Compliance
LLPs and LLCs have business formalities to keep up with after they have formed their entities. Failure to comply with the requirements can result in fines, penalties, loss of liability protection, and even forced closure.
What a business must do to stay compliant will vary depending on their type of business, industry, and location, so it’s helpful to speak with an attorney and accountant or tax advisor for insight. Corpnet’s Compliance Portal is also a helpful resource for monitoring many compliance requirements and due dates.
LLP Business Compliance
Some examples of ongoing business compliance obligations that an LLP may need to fulfill include:
- File an annual return or report
- Hold an annual meeting and record minutes
- Maintain a partnership agreement at the business’s principal office
- Pay estimated income taxes quarterly
- Retain a registered agent
- Renew licenses and permits
- Renew fictitious name registration
- Notify the state of any major changes (adding new members, name change, address change, etc.)
LLC Business Compliance
Some examples of ongoing business compliance obligations that an LLC may need to fulfill include:
- File an annual report
- Hold an annual meeting and record minutes
- Maintain an LLC operating agreement at the business’s principal office
- Pay estimated income taxes quarterly
- Retain a registered agent
- Renew licenses and permits
- Notify the state of any major changes (adding new members, name change, address change, etc.)
Form Your LLP or LLC With the Help of CorpNet’s Business Filing Experts
After discussing all of the advantages and disadvantages of the LLP and LLC entity types with an attorney and accountant or tax advisor, contact CorpNet when you’re ready to form an LLC or another business structure of choice. Our filing experts have helped tens of thousands of business owners prepare and submit their critical business registration forms and fulfill their other compliance requirements. We’re here to help you launch your new business and successfully start your journey to entrepreneurship!
CorpNet.com is a document filing service and cannot provide you with legal, tax, or financial advice. The information provided is for general educational and informational purposes only. It should not be considered legal, financial, or tax advice. Please consult a licensed attorney, accountant, or tax advisor to address your specific legal, tax, and accounting questions or concerns.
