The main difference between an LLP (limited liability partnership) and LLC (limited liability company) is that the LLP provides business asset protection from another partner’s negligence. If one partner were to get sued because of negligence, only that partner’s assets are held liable. Common LLP businesses are law, accounting, and architecture firms.
When To Form an LLP
You form an LLP as your business’s legal entity if you don’t want to be held liable for your other business partners’ actions. For example, if there’s an accounting firm with three partners with equal ownership (33% each) and one were to get sued by a client, only that partner’s share is held liable, not 100% of the company.
Tip: LLPs are only available in 40 states. If it is available, it’s only for specific professions. For example, California only allows licensed lawyers, accountants, and architects to form an LLP.
When To Form an LLC
If your business has partners and isn’t eligible for the LLP (e.g., your state doesn’t allow LLP formations), you’ll want to form a multi-member (multi-partner) LLC. This option will provide you with personal liability protection from a business lawsuit or bankruptcy.
When To Use an Alternative
You may also be wondering if you should form an S corporation (S-corp) or a C corporation (C-corp). The S corporation is not a business legal entity and is technically a tax status favorable to small businesses. You can elect S-corp tax status when you register as either an LLC or a corporation.
Forming a C-corp is a reasonably complicated process, and you’ll likely need a business attorney’s assistance. Many companies choose to start a C corporation because it is more favorable to raising capital from investors. Other companies must create a C-corp for legal reasons, such as having over 100 shareholders or a foreign shareholder.
LLP vs LLC at a Glance
Liability Protection | All partners are protected from the negligence and wrongdoing of other partners | Members (partners) are not protected from the negligence and wrongdoing of other members |
Tax Treatment | Self-employment tax, Pass-through on profits, Additional taxes in some states | Self-employment tax, Pass-through optional, Optional S-corp election, Additional taxes in some states |
Costs | Formation fee: $40–$500 Annual filing fee: $40–$500 Add’l State Tax: $0–$800 | Formation fee: $40–$500 Annual filing fee: $40–$500 |
Ease of Formation | More paperwork required for setup and must show professional license | Easy to establish and single-member LLCs possible |
More Information |
Liability Protection
The LLP protects one partner from another’s negligence, debt, and wrongdoing. For example, if a client sued an attorney for negligence, only their capital investment in the business is held liable, not every partner’s capital investment.
Note: States vary drastically when it comes to LLPs. Some states require all partners to share liability in a business bankruptcy; other states don’t. Check with your state’s official business registration website or a local business attorney for more information.
When forming your business, keep in mind the situations where the liability shield is forfeited:
- Committing fraud: If you defraud clients, vendors, or investors through your business, you can open yourself to liability.
- Practicing improper administration of the company: Failing to meet the legal requirements of an LLC, like holding annual meetings, can create personal liability.
- Commingling personal and business funds: Keeping company money in your personal checking account can leave you personally liable for business activity.
- Using personal money to meet LLC obligations: Personally paying company bills can open you up to liability.
- Capitalizing the LLC at startup insufficiently: Forming a company without sufficient resources to meet its initial obligations can cause problems later on.
Taxes
The taxes for the LLC and LLP are fairly similar. States typically allow what’s called “pass-through” taxation. For both, you will pay a 15.3% self-employment tax. The income after the tax will “pass-through” to your personal income tax bracket.
The main difference between an LLC and LLP regarding taxation is the LLC’s ability to elect S corporation tax status. The S-corp tax status helps a business owner save on taxes by only charging the 15.3% on the owner’s salary, not the entire income (which is called a dividend). The tax savings on a dividend could be thousands of dollars every year.
Costs
In most states, the costs for setting up and maintaining the LLC and LLP are similar. However, you may find an additional fee for the LLP. For example, California charges LLPs an annual flat tax of $800.
Depending on your state, the costs to form an LLP and LLC can vary a lot. Here’s a rough cost estimate of what you can expect:
- Initial filing fee: $40 to $500 (the fee to set up an LLC)
- Annual filing fee: $40 to $500 (the cost when you submit yearly filings to keep an LLC current)
- LLP yearly state tax: $0 to $800 (the possible additional yearly tax for an LLP—charged by the state)
How To Register an LLP and LLC
The steps to register both the LLC and LLP are similar. Typically, it can be done yourself online through your Secretary of State’s website or another official business registration website. Here are the steps to take if you’re registering an LLP or LLC yourself:
- Obtain an Employer Identification Number (EIN).
- If you’ll form a partnership, draft your partnership agreement.
- Visit your state’s official business registration website.
- Submit the articles of organization and other requested information.
- Choose your registered agent.
- Document when you need to renew your LLC or LLP with the state.
Many business owners find the above legal steps difficult to follow on their state’s business registration website. If you’d like professional assistance, consider IncFile, an online legal service. It will submit your LLC and LLP documents to the state for free plus any state fees.
Bottom Line
Both LLPs and LLCs are simple, easy-to-use business structures that are ideal for those starting a business. They both provide owners with personal liability protection and are relatively cost-effective to establish and maintain. Overall, LLPs are best for certain licensed professions, while LLCs are better for other types of businesses.
