Difference Between LLC and LLP
Difference Between LLC and LLP
When starting a new business, it’s important to choose the business structure that meets your business needs. Some of the most common questions a business owner asks are: “What is an LLC and what is an LLP?” and “What is the difference between LLC and LLP?
Both a limited liability company (LLC) and a limited liability partnership (LLP) combine aspects of a corporation and a partnership. It is important to understand the difference between an LLC and LLP because choosing between a LLC vs. LLP can have long-term repercussions for your new enterprise. So, what are the biggest differences between a limited liability company vs. limited liability partnership?
What is an LLC? A limited liability company is a legal entity that combines the limited liability protection of a corporation with the tax benefits of a partnership and is commonly favored by small businesses. An LLC can have one or more owners – referred to as members – that include corporations, individuals, foreign entities and other LLCs.
Keep in mind not every business can operate as an LLC so check your state statutes. The banking and insurance industries, for example, are typically prohibited from forming an LLC, while some states like California and Nevada prohibit licensed professionals – accountants, architects, attorneys, physicians – from forming an LLC. However, licensed professionals who want the same benefits as an LLC can form a professional limited liability company (PLLC) in most states, except California.
What is an LLP? An LLP is a general partnership formed by two or more owners – referred to as partners – and the LLP definition is similar to that of an LLC. It is a cross between a corporation and a partnership, and the partners enjoy some limited personal liability. Professional businesses are commonly organized as an LLP.
There is one significant difference between LLP and LLC. An LLP must have a managing partner that is liable for the actions of the partnership. As long as silent partners and investors don’t assume a managerial role, they receive liability protection.
About 40 states allow the formation of an LLP, and the laws vary by state. Some states limit what professions can form an LLP, so check your state statutes.
Note: If your business plans to operate in multiple states, check the state’s statutes to ensure the state recognizes a foreign LLP – a LLP formed in another state. For example, a state that limits what professions can form an LLP may not recognize an LLP from a state that doesn’t and this can have personal liability repercussions.
What is the Difference in Management Structures?
There are two common management structures for an LLC. LLC members can manage the business themselves – commonly referred to as member management -- or hire or appoint one or more members and/or non-members to manage the business – commonly referred to as manager management. Unlike a member management structure where each member shares responsibility for running the business, the management team runs the business under a manager management structure and the remaining members aren’t involved in business decisions.
An LLP operates like a general business partnership, where management duties are equally divided between partners. A partnership agreement should set out how business decisions will be made.
What is the Difference in Limited Liability Protection?
While both LLCs and LLPs provide members and partners, respectively, with limited liability protections, there are differences between LLC and LLP.
- LLC members are protected from personal liability for business debts and claims; that means a creditor cannot sue to recover a member’s personal assets if the business can’t pay its debts. The members only lose their monetary investment. However, if a member commits an act that is legally actionable, both the LLC and its members can be held liable
- Each partner in an LLP, however, is personally liable only for their own negligence; partners are not liable for another partner’s mistakes and only risk their capital investment in the LLC
- In some states, partners in an LLP can be personally liable for partnership debts. It’s important to check your state’s statutes
Note: Some states require LLPs to carry liability insurance, while others require LLPs to post a bond or some form of financial security.
What is the Difference in Tax Benefits?
While LLCs and LLPs are not recognized as business entities by the Internal Revenue Service (IRS) and don’t pay income taxes, each is required to file an informational tax return. Unless a LLC elects to file a corporate return, it is treated like a partnership. Certain LLCs, however, are required under federal tax laws to file as a corporation.
In a partnership, the business earnings are passed through to the partners who report the profits and losses on their personal federal income tax returns. A LLC avoids double taxation – paying corporate taxes on its earnings and paying personal income taxes on the same earnings – by filing as a partnership. A one-person LLC is a sole proprietorship and the member must file self-employment taxes.
Note: Some states require LLCs to file a state tax return so check with your state’s income tax agency and some states don’t allow pass through taxation and impose a state franchise tax on LLPs.
It’s important to choose the right business structure to protect your new business from unforeseen legal and tax consequences. When choosing between a LLP vs. LLC, check the state statutes to make sure the legal entity can operate in your state. While LLPs and LLCs share many similarities, there are also differences between them so choose the one that works for you. While forming one is relatively easy and as simple as filling out some paperwork, always check with an attorney if you need help.
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