In this post, I am going to compare two popular business structures a limited liability company (LLC) and a limited liability partnership (LLP). If you have been following my posts, you must be familiar with the seven steps to forming an LLC.
Shortly, I shall highlight the key differences between an LLC and an LLP regarding the formation process. Next, I shall highlight the most important advantages and disadvantages of each business entity.
The juice and meat of this post are going to be the tax treatment of a limited liability company and a limited liability partnership. After all, the difference in taxation may tip the scales in favor of one business type or the other.
LLC vs LLP: Business organization
To set up an LLC, you need to have an Operating Agreement prepared and filed with the secretary of state by a reputed and reliable LLC formation service like ZenBusiness. The principal formation document of an LLP is called Partnership Agreement. The partnership agreement outlines each partner’s duties, liabilities, and decision-making powers.
A limited liability partnership (LLP) is a business structure in which each partner is protected from personal liability for the business’s debts and obligations. Partners can manage the company together, or they can elect a managing partner.
In any case, they enjoy personal assets protection, should the business entity be sued due to other partners’ negligence. In order to form a limited liability partnership, you need to register your business with the state via a registered agent service.
LLC vs LLP: eligibility requirements
You can file to form an LLC everywhere in the USA, but some states restrict ownership of LLPs to specific groups of professionals: attorneys, architects, accountants, etc. Every state has its own list of professionals who are allowed to form an LLP. The state of California, for instance, allows only groups of public accountants, architects, surveyors, lawyers, or engineers to form this type of business entity.
General partnership vs limited liability partnership
In a general partnership, all partners manage the business together and are equally liable for its misfortunes. Every partner is liable for the debts and obligations of the partnership with their personal assets.
If Tom, Dick, and Harry ran a gardening partnership together and Dick accidentally damaged a customer’s lawn, the customer could sue the three partners and come after each one’s personal assets to seek compensation for the caused damages.
That’s a lot of liability for every partner to shoulder, so many professionals choose to form a limited liability partnership (LLP) instead. In a limited liability partnership, partners are not personally liable for the debts and obligations of the business.
If they are Business partners in an LLP, Tom, Dick, and Harry can certainly lose their investments if the business entity doesn’t do well. However, the personal assets of each partner will be safe from creditors due to the liability protection that an LLP provides.
LLP vs LP
There is yet another variation on a partnership called a limited partnership (LP). In every limited partnership, there are two types of partners—general partners and limited partners. General partners are personally liable for the actions of all other partners as well as the partnership’s debts.
Limited partners invest in the company, but they enjoy certain limited liability protection. So, the limited partners are only liable up to the amount of their investments. An LP is a suitable business structure for family-owned businesses and real estate agencies.
How to form an LLP?
It appears that the process of LLP formation is two steps longer than that of an LLC. Here is what you should do
Check your eligibility status
Check out your state’s rules and regulations concerning limited liability partnerships to see whether your business is eligible to form one. As I mentioned above, many states limite the number of professions that can establish an LLP. The states of California, Oregon, and Nevada, and New York, have strict restrictions on what sorts of professional services an LLP can offer.
Choose an available business name
Your partnership’s business name needs to reflect its businesses operations. You should check your secretary of state’s database to make sure the business name you have selected isn’t taken. A formation service like ZenBusiness can do this for you. Make sure to add LLP at the end of your business’s name to specify the business type.
Sign up for a registered agent service
when forming and LLP and LLC, you are going to need registered agent service. Many formation companies sell their registered agent services separately. However, the registered agent service of ZenBusiness is included in each of the company’s business formation packages. The registered agent service accepts all legal papers on your LLP’s behalf and notifies you of any pending lawsuits against your business.
File license applications as needed
Make sure to apply for all of the required business licenses in your state, so that your LLP can start perfoming business operations. If you’re an attorney in California, you need to register your LLP with the California State Bar once you receive approval from the Secretary of State.
File an LLP certificate
The LLP certificate formally allows your LLP to comemnce business operations. You must file the LLP certificate with the Secretary of State’s Office. When, applying, you must provide your business’s name, registration address, the names and contact information for the partners, as well as the LLP’s registered agent’s contact information. The filing fee ranges between $50 and $100.
After your application has beem processed, you will receive a stamped copy, which you should keep with your LLP’s records. Online legal services like ZenBusiness can help you register your limited liability partnership.
Get a law firm to prepare your partnership agreement
A partnership is optional for an LLP, but it’s highly recommended. The partnership agreement spells out each partner’s scope of liability, as well as their protected assets. The partnership agreement also specifies the scope of liability protection each partner is entitled to. In this respect, the partnership agreement is each partner’s insurance against personal asset seizing.
LLPs need special insurance policies
Limited liability partnerships with employees need to purchase workers’ compensation insurance while the partners in licensed professions need to purchase malpractice insurance.
Maintain good standing with the state
LLP owners need to constantly maintain compliance with the state regulations while running the business. Many LLC formation companies can provide an ongoing compliance service for your LLP as well. For example, the worry-free compliance service of ZenBusiness costs just $119 a year.
LLPs need to file for an EIN
LLPs are like LLCs in that they are required to file for an Employer Identification Number (EIN) with the Internal Revenue Service (IRS). LLPs also have to pay federal payroll taxes if they have employees.
LLC Tax Advantages
For tax purposes, the Internal Revenue Service (IRS) considers an LLC with more than one member a partnership. This means that taxes for both LLPs and multiple-member LLCs are filled in a partnership tax return.
However, an LLC may choose to be taxed as a C corporation or an S corporation. By contrast, LLPs cannot file taxes as S corporations. Moreover, single-member LLCs can choose to be taxed as sole proprietorships via the owner’s tax return. In this case, the owner pays personal income tax and applicable state licensing fees.
By contrast, LLPs and multi-member LLCs file IRS Form 1065, in which the profits or losses are divided between the business partners based on their percentage of ownership. Each partner receives a Schedule K-1 for his or her ownership share. This share is then included in the owner’s personal tax return.
LLP Tax Advantages
The business partners in a limited liability partnership (LLP) are not personally liable for the debts of the business and report their share of business income and losses on their personal tax returns. This is called pass-through taxation.
In pass-through taxation, the partners pay their business taxes at their individual tax rate, as opposed to a corporate tax rate. However, limited liability partnerships often have to pay registration fees and franchise taxes depending on their formation state.
LLC and LLP: which one is for me?
Limited liability companies can operate as a sole proprietorship just as well. Therefore, they are a more appropriate business structure for small business owners. At the same time, a Limited Liability Company LLC offers great personal liability protection and flexible taxation options. In a multi-member LLC, ownersenjoy the same amount of liability protection unless an owner is a manager.
Attorneys usually form LLPs, because they have a better understanding of the applicable state laws than the average business owner. LLPs allow owners to exercise passive ownership with no management responsibility and lower liability as limited partners.
An LLP may be the more suitable business structure for licensed professionals like architects or attorneys, but it also requires a lot of preliminary work before the partners can start working. Furthermore, in Tennessee and West Virginia the partners in an LLP are exposed to negligence claims.