While both represent legal entities, the main difference between LLPs and LLCs is the level of liability protection. An LLP provides business asset protection from another partner’s negligence, whereas with an LLC, all members are protected from personal liability from business debts.
If you’re wondering which option is better suited for your business, there are various factors to keep in mind, as the right structure can protect your finances, legal endeavors, and even your tax implications. Before making a decision, consider these differences:
Liability Protection
Both LLPs and LLCs provide some form of liability protection. However, there are notable differences to consider when determining who’s liable in certain events.
An 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. This differs from an LLC, where it shields all members of a company against liability instead of a single partner. Only the LLC is on the hook for debts or liabilities, not the individuals and their personal assets.
When forming your business, keep in mind the situations where the liability shield is forfeited:
- Committing fraud: Defrauding clients, vendors, or investors through your business opens you up 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; learn how to separate business and personal finances to ensure proper allocation of income and to simplify tax season.
- 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.
Management Structure
Management structures between an LLP and LLC differ in that an LLP usually has shared management responsibilities among partners, where decisions regarding the business are equally made. Meanwhile, an LLC tends to be more flexible and has either designated managers that run the business—or the business is member-managed.
State Level Differences
Some states only allow certain industries to have an LLP structure. For example, California only allows licensed lawyers, accountants, and architects to form an LLP, per California’s Franchise Tax Board. New York has similar restrictions. In contrast, LLCs can be formed in all 50 states. That said, there will be varying requirements and regulations by state.
Some other states have additional requirements for LLPs that do not apply to LLCs. For example, Delaware, Georgia, Pennsylvania, Texas, and Virginia require LLPs to maintain escrow accounts to cover business liabilities, in addition to general liability insurance requirements.
Several states (Alaska, Arkansas, Washington, D.C., Hawaii, Illinois, Kansas, Kentucky, Louisiana, Maine, Michigan. Nevada, New Hampshire, New Jersey, North Carolina, Ohio, Pennsylvania, South Carolina, Tennessee, Texas, Utah, and West Virginia) have limits on how far each partner’s personal liability extends in an LLC. In these states, an LLC might offer more liability protection than an LLP.
Before making your final decision between an LLC versus an LLP, check with your state’s business regulating agencies (like your state’s Secretary of State’s office) to ensure that you meet the necessary qualifications.
Ownership
Ownership qualifications are slightly different for LLCs versus LLPs. The major difference is in the number of owners. If your business has a single owner, an LLC is the only option between an LLP and an LLC. In most states, businesses with two or more owners, LLC and LLP are both options. There are other differences to consider:
- LLC: LLCs offer flexible ownership. They are owned by “members,” who can be managers or simply investors. Members can arrange their own management and profit-sharing structure. LLC members can be individuals, corporations, US citizens, or international entities. LLCs can be owned by single individuals.
- LLP: An LLP is owned by “partners” who all have a management role. This ownership arrangement makes the most sense for medical practices, lawyers, architecture firms, and other businesses where several individuals provide individualized services.
Formation
The process of registering a business as either an LLC or an LLP is fairly similar. Typically, you can do it yourself via your Secretary of State’s website or another official business registration website.
- LLC: LLCs are typically easy to set up and register with your state. They support a range of business types. On the other hand, LLCs are quite simple to establish and are also available to single-member LLCs.
- LLP: LLPs typically require more paperwork to set up than LLCs, and you’ll be required to present professional licensure depending on the business industry, and the state where your business is located.
Business Activities
For most small or midsize businesses, an LLC is likely the better choice to encompass the protection of all members of the business. It can also be applicable to a wide variety of industries and isn’t as limiting as an LLP.
Some businesses may be better suited for an LLP such as accounting, law, or architecture, in which partners are protected as individuals.
Taxes
The main difference between an LLC and an LLP regarding taxes is an LLC’s ability to elect S-corp tax status, which 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.
Other tax considerations for both an LLC and an 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.
Costs
In most places, the costs to establish an LLC and a LLP are similar. However, in some states, LLPs are subject to an additional yearly state tax. Here’s a rough cost estimate of what you can expect:
- Initial filing fee: $35 to $500 (the fee to set up an LLC)
- Annual filing fee: $0 to $800 (the cost when you submit yearly filings to keep an LLC current)
- LLP yearly state tax: Varies (the possible additional yearly tax for an LLP—charged by the state)
Forming an LLP vs LLC
Both LLP and LLC entities allow business owners to separate their personal assets from business assets; however, as discussed above, there are notable differences between the two in how their management and protection structures work.
When to Form an LLP
Set up an LLP if you don’t want to be held liable for your other business partners’ actions. This is because the entity type grants individual partners within a company individual protections, rather than being liable for the actions of other partners. 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.
When to Form an LLC
If your business has partners and isn’t eligible for the LLP type (e.g., your state doesn’t allow LLP formations), you’ll want to form a multi-member (or multi-partner) LLC. This will provide you with personal liability protection and protect your personal assets from a business lawsuit or bankruptcy. An LLC is a commonly used business structure that is typically utilized by small businesses and is considered to be a flexible option for both partnerships and sole proprietors.
When to Consider Alternatives
You may also be wondering about applicable business types or if you should form an S corporation (S-corp) or a C corporation (C-corp).
- Note that an S-corp is not a legal business structure; it 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 choose to start one 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.
Frequently Asked Questions (FAQs)
It depends on a few factors. Mainly, it has to do with how your business is structured and the type of protection it needs. An LLP is better suited for professional businesses needing to protect the personal assets of their partners, whereas an LLC is better suited for companies in which personal liability protections are extended to all members.
Some downsides to an LLP structure are that they aren’t available in every state, are only applicable to certain types of businesses, and tend to have more extensive filing requirements than an LLC.
The owners within an LLP business structure are called partners. To be considered an LLP, there must be at least two partners involved in the business, which can be represented by individuals, corporations, or other types of entities.
Bottom Line
Choosing between a limited liability company vs limited liability partnership can be challenging if you’re unsure of their respective protections, as both are business structures to consider when starting a business. Liability protection is provided by both; however, there are notable differences between these entities and what they can provide overall.
Both are relatively cost-effective to establish and maintain and can have varying benefits depending on your needs. Overall, LLPs are best for certain licensed professions, while LLCs are better for other types of businesses.