LLC vs LLP: What Are The Differences?
It is important to understand the full implications of forming a limited liability company (LLC) or a limited liability partnership (LLP) before registering your startup.
In the course of starting a new business venture, you may want to explore different business entities to limit your personal liability. Both are easy to set up, but may not be relevant to every business in every state.
Difference Between LLC and LLP
There is a difference between an LLC and an LLP. An LLC is a limited liability company and an LLP is a limited liability partnership.
Below we provide a detailed description of the differences between an LLC and an LLP:
What Is An LLC?
The limited liability company (LLC) is a separate business entity with one or more owners, referred to as members. By filing the appropriate paperwork with your secretary of state, you can form an LLC. Typically, this involves filing articles of incorporation, paying an incorporation fee, and drafting an operating agreement.
An LLC that has been properly formed is a separate legal entity from its owners, which means it owns business property, maintains a business bank account, and has its own tax identification number.
What Is An LLP?
The limited liability partnership (LLP) is essentially a general partnership with the addition of limited liability for one or more partners. When two or more people do business together, a general partnership is formed. It does not require any legal filings. If you want to create an LLP, you must file additional paperwork with the state. A limited liability partnership is a separate business entity, just like an LLC.
Comparing LLC and LLP
Consider the differences between the two different types of business structures before forming your business.
Liability Protection
An LLC and an LLP offer some protection against personal liability by limiting the amount of liability to the amount invested by each partner or member. Generally speaking, an LLC offers the best liability protection. If the LLC is sued or owes any debts, members are not personally liable, except in cases of business mismanagement. The purpose of this is to protect members’ personal assets such as their houses, bank accounts, and cars.
In some states, LLP partners have limited liability like LLC partners, but this depends on where the LLP was formed. An LLP only protects you from being held accountable for another partner’s negligent acts, but the partners remain personally liable for the business’s debts and obligations. Additionally, some states require that one partner has unlimited personal liability, while the other partners are protected.
Taxation of LLCs and LLPs
LLCs can choose to be taxed as sole proprietorships, partnerships, or corporations. On the other hand, LLPs must file as partnerships. Sole proprietorships and partnerships entail that business income is passed through them, and the tax is only paid once as individual income. As a corporation, the business pays tax on its corporate tax return, and the same income is taxed again on the individual tax return.
LLCs and LLPs can both take advantage of the 20% pass-through deduction. Therefore, you can deduct up to 20% of your business profits from your personal tax return. However, this complex tax break has some limitations.
LLC and LLP: Difference in Management Structures
There are other differences between the two entities, such as the method of determining the management structure. A Limited Liability Company can have only one member, while a Limited Liability Partnership must have at least two partners. Business partners are, in essence, equally responsible for running the business.
Agreements for LLC and LLP
LLC and LLP are both based on different agreements, these agreements are:
Operating Agreement For LLC
An LLC is managed based on its operating agreement, which is created by its members. It summarizes the financial contributions made by each member of the committee, how profits will be distributed, and who will be in charge of management decisions.
Partnership Agreement For LLP
In a limited liability partnership, the management structure is defined by the partnership agreement. As with the operating agreement, the partnership agreement stipulates which partners play which roles, how much they contribute, and how profits are distributed.
Legal Protections
Even though it may seem like there are a few differences between LLCs and LLPs, there are some things to keep in mind. A limited liability partnership (LLP) is the only structure that will offer protection from a partner’s wrongdoing, and such a business is usually professional in nature.
You can expect to be better protected from liability if you have an LLC. There will be a limited liability, but you will not be fully protected from the actions of other members, as in an LLP. Members of LLPs may still bear the burden of paying back business debts that cannot be repaid due to a failing business while the protections exist.
Choosing the Right Business Structure
To protect your new business from unforeseen legal and tax repercussions, you need to pick the right type of business structure.
You should check the state status to make sure that the legal entity can operate in your state before choosing an LLP or LLC. Even though LLCs and LLPs have many similarities, they also differ in many ways, so choose the one that best fits your situation.
Although forming one is relatively straightforward and as simple as filling out some paperwork, it is always best to seek legal advice before you do so.
Start your dream business with us by forming your business entity today
FAQs:
LLC stands for Limited Liability Company. It is a business structure that provides limited liability protection to its owners (members) while offering flexibility in management and tax options.
LLP stands for Limited Liability Partnership. It is a business structure commonly used by professionals, such as lawyers, accountants, and architects. LLPs offer limited liability protection to partners while allowing them to participate in the management and operation of the business.
The key difference lies in the management and liability aspects. In an LLC, the owners (members) have flexibility in management and are protected from personal liability for business debts. In an LLP, partners can actively participate in managing the business and are typically protected from personal liability for the actions of other partners.
LLCs can be formed by various types of businesses, including single-member LLCs and multi-member LLCs. LLPs, on the other hand, are typically used by professional service providers who require liability protection for themselves and their partners.
LLCs have flexibility in tax options and can be taxed as a disregarded entity, partnership, or corporation. LLPs are generally taxed similarly to partnerships, where the income and losses pass through to the partners’ personal tax returns.
