The first step in starting a new business is deciding on the most suitable business structure. Before deciding to start an LLC (limited liability company) or LLP (limited liability partnership), you must note that each type of business comes with its own benefits and drawbacks.

Before making your choice, you should always look at the potential limited liability, tax advantages, and ownership structure. Whether you start an LLP or LLC will depend on your business goals, the size of your business, and the flexibility you’re looking for when running your business.

Entity type Liability Taxation Maintenance
Limited liability company A pass-through tax structure combined with limited liability protection. According to the IRS, LLCs may choose whether they want to be taxed as corporations or partnerships. LLCs must hold annual meetings, record minutes of meetings, issue stocks to shareholders, and file individual state and federal income tax returns to remain compliant.
Limited liability partnership Although LLPs offer limited liability protection, some states may vary on their definition and the regulations surrounding the liability protection afforded to LLPs. LLPs are considered pass-through entities, and the company itself pays no taxes, while profits and losses are reflected on the partner’s personal income tax returns. LLPs must file annual returns, financial statements, as well as income tax returns to remain in good standing.

What is an LLP?

An LLP is a general partnership formed by a minimum of two people referred to as the owners or partners. Much like an LLC, an LLP combines a partnership and a corporation where the partners enjoy some limited personal liability. Professional businesses are usually formed as LLPs.

LLP benefits

  • Straightforward formation process: While forming a limited liability partnership requires paperwork and filing fees, it’s a fairly straightforward process. An LLP owner must complete the documentation required by the Secretary of State’s office. Some documentation includes a Certificate of limited liability partnership and the filing fee that varies from state to state. Annual reporting may also be required and varies from one state to the next. However, it usually includes basic reporting such as your business address, registered agent’s name, and the number and names of partners in your company.
  • Taxation: Since limited liability partnerships are taxed as pass-through entities, LLP members must include profits and losses from the business on their personal tax returns.
  • Limited protection: In a limited liability partnership, each partner’s liabilities are limited to their investment or the amount of money they’ve put into the business.
  • Flexibility to evolve: As long as the partnership agreement allows for new partners to join and long-term members to move on, there should be no disruption to the business itself.

LLP drawbacks

  • Not allowed in every state: Some of the reasons why limited liability partnerships are not allowed in every state are due to the complex nature of tax filings with this business structure and the fact that it’s not regarded as a legal entity in many states. The states that allow LLP formations have restrictions on what type of professionals may set up an LLP and may impose heavy tax limits on them both during formation and throughout their operations.
  • Less credibility: LLPs have less credibility than other types of business entities. This is one of the reasons many entrepreneurs choose to form actual corporations as opposed to LLPs.
  • Partners don’t have to consult each other: Another drawback of a limited liability partnership is that the individual partners do not have to consult each other when conducting certain business activities.
  • Disclosure of financial records: One of the mandatory requirements is that financial records must be submitted for public record.

Read more about LLPs.

What is an LLC?

An LLC is a business entity that limits the liability of its owners, also known as members. While any business is allowed to create an LLC, you cannot have an LLC for professionals who require a license to operate.

A limited liability company is considered a hybrid business entity as it combines the characteristics of a corporation with that of a sole proprietorship or partnership. While both limited liability companies and corporations enjoy similar liability protections, the availability of flow-through taxation, also known as pass-through taxation to LLC members, is a feature that comes with partnerships rather than LLCs.

LLC benefits

  • Pass-through taxation: LLCs are not liable for taxes at the corporate level. Both profits and losses due are passed-through to the members for them to report on their personal income tax returns. Therefore, all taxes due are paid at the individual level.
  • Management structure: The management structure with LLCs is quite flexible. LLCs may choose to have the members manage the business, called a member-managed LLC. Alternatively, they can elect a manager from outside of the company to manage the business, called a manager-managed LLC.
  • Increased credibility: As opposed to forming a partnership or sole proprietorship, an LLC carries far more weight with clients, lenders, and suppliers. This is because LLCs are considered a formal business structure.
  • Flexible membership: Members of an LLC may be partnerships, individuals, corporations, or trusts, and there’s also no restriction on the number of members.
  • Limited liability: Members of an LLC are not held personally liable for the negligence of the company or other members. Therefore, the personal assets of LLC members are off-limits to creditors in case of business debts, malpractice, or lawsuits.
  • Limited compliance requirements: In terms of ongoing maintenance and compliance, LLCs must adhere to fewer state-imposed compliance requirements and ongoing filings compared to other business entities.

LLC drawbacks

  • Transfer of ownership: Transfer of ownership with corporations is often an easier process compared to LLCs. So unless the operating agreement allows it, all LLC members must consent or approve the addition of new members and any changes in the ownership percentages of existing members.
  • High costs: Unlike forming a general partnership or sole proprietorship, LLCs tend to cost more to create and maintain. Aside from the initial formation fee, LLCs are subjected to ongoing maintenance fees such as franchise tax and annual reporting fees.

At a glance: How is an LLC different from an LLP?

Let’s take a look at the key differences between Limited liability companies and limited liability partnerships:

  • In some states, limited liability partners are shielded from liability if another partner faces negligence or malpractice claims.
  • Regarding taxation, LLCs are afforded more options than LLPs, such as electing to be taxed as an S corp.
  • When forming a limited liability partnership, only individuals are allowed to be partners compared to creating an LLC, where other partnerships or trusts can also be members of the company.
  • While LLCs are allowed to have a single owner, LLPs must have a minimum of two owners. Hence, it is referred to as a “partnership.”

LLC vs. LLP: Taxes

One of the biggest advantages or disadvantages of any business is how the different structures are taxed. For example, when it comes to paying taxes on an LLC and LLP, it’s different with both entity types. So let’s take a closer look at LLC taxes vs. LLP taxes.

LLC taxes

  • LLCs may be taxed as partnerships, sole proprietorships, C corporations, and S corporations.
  • Single-member LLCs are taxed as sole proprietorships.
  • One of the best structures to elect is the S corp status, which allows you to maintain pass-through taxation. (However, you’ll greatly reduce self-employment taxes.)
  • Many people choose to elect the S Corp status because members of an S Corp are only liable for Medicare and Social Security taxes on the income taken as salaries.
  • Dividends or any income taken as distributions are not liable for self-employment taxes.

LLP taxes

  • Regarding tax purposes, the Internal Revenue Service (IRS) sees LLPs as pass-through entities.
  • Ultimately, this means that the profits and losses of LLPs are reflected on the business partners’ personal income tax returns.
  • So the limited liability partnership itself is not liable to pay corporate taxes.
  • LLPs must also file annual information returns to report their operations’ gains, losses, income, deductions, etc.

Read more about LLC types.

LLC vs. LLP: Formal requirements

The formation requirements for both LLCs and LLPs have similarities as well as differences:

Formal requirements for LLCs

  • When forming an LLC, the Articles of Organization, often called the Certificate of Organization, must be filed with the state along with payment of the relevant filing fees.
  • Additionally, LLCs should have an operating agreement at their place of business.
  • While this is not compulsory, it will come in handy in resolving disputes between members somewhere down the line.
  • Therefore, the operating agreement, if one is drawn up, does not need to be filed with the Secretary of State’s office. However, it must be kept on record for reference, as and when needed.
  • Some states may also require that LLCs publish a newspaper notice to inform the public of the limited liability company’s formation and ownership.

Formal requirements for LLPs

  • When forming an LLP, partners of the LLP must file the required business registration documents and pay the relevant filing fees with the state agencies.
  • LLPs should preferably have a written partnership agreement.
  • As with the operating agreement for LLCs, the partnership agreement does not need to be filed with the Secretary of State’s office. However, it must be kept at the LLP’s place of business.
  • Some states might also require that LLPs publish a copy of their registration or the notice of formation in newspapers.

Ongoing compliance

Regarding other business structures such as corporations, LLCs and LLPs have minimal ongoing business compliance requirements. Once again, this may vary from one state to the next and may also be based on the LLC’s operating agreement or the LLP’s partnership agreement.

However, some ongoing compliance requirements for LLCs and LLPs may include filing annual reports with the state, maintaining the operating and partnership agreements at the desired address, maintaining a registered agent, reporting and paying estimated income taxes, and renewing licenses and permits.

LLC vs. LLP: Management

LLCs and LLPs are fairly easy to manage, with the majority of flexibility stemming from the operating agreement and partnership agreement:

Management flexibility for LLCs

  • Owners of a limited liability company are considered members. Additionally, LLCs may be manager-managed or member-managed.
  • How the decision-making process, as well as the management process, is structured comes with a great deal of flexibility.
  • It’s important to create an operating agreement so that the management structure, as well as the rights and responsibilities of the members, may be detailed and put on file.

Management flexibility for LLPs

  • Owners of a limited liability partnership are known as partners.
  • LLPs come with great flexibility regarding how the business is managed.
  • Additionally, the profit-sharing, rights, and duties, as well as the operation structure itself, are all outlined and contained in the partnership agreement.

LLC vs. LLP: Ownership structure

The ownership criteria for both LLCs and LLPs differ, and state laws play a huge role in the restrictions and limitations on what type of business structure you may form:

Ownership structure of LLCs

  • An LLC is allowed to have one (single-member LLC) or more owners (multi-member LLC).
  • These members may be individuals, corporations, other LLCs, or foreign entities. However, depending on the state laws or requirements, certain types of businesses may be restricted from forming an LLC.
  • In most cases, when certain types of companies and certain types of licensed professionals are not allowed to start LLCs in a specific state, they usually allow you to start a PLLC or professional limited liability company instead. PLLCs are for professionals who require a license to operate, such as architects, accountants, and lawyers.
  • The LLC operating agreement ultimately ensures that the percentage of ownership and the responsibilities and roles of all members are documented.

Ownership structure of LLPs

  • Limited liability partnerships are allowed to have at least two or more partners.
  • The business management is ultimately left to all the company’s partners.
  • Likewise, all of the partners experience limited personal liability.
  • In certain states, such as California, only certain licensed professionals, such as architects, lawyers, and accountants, may form an LLP.
  • A partnership agreement is crucial to documenting the responsibilities, goals, and ownership percentage.

Summary

Selecting the correct legal structure for your business is one of the more important decisions you will make at the onset. Remember to always compare the advantages and disadvantages of asset protection, ownership, and control, as well as costs and taxation.

You may also find that you’re limited to your choice of a legal entity based on the type of industry you’re in and the state laws you are required to comply with. Ultimately, note that each business structure or entity type has benefits and drawbacks, and there are better choices than one entity type.

FAQs

Should I start an LLC or LLP?

When deciding on an LLC or LLP business structure, you must consider some factors, including liability, taxes, ownership, and management. You also need to keep your business goals in mind and ensure that the structure will work for you in the long run.

Where can I find my state’s specific filing requirements?

While limited liability companies and limited liability partnerships are two common structures, and they may sound very similar, their differences exist. The best way to find out your state’s specific legal and filing requirements is to check on the Small Business Administration’s website (SBA).

What’s the difference between a general partnership and a limited partnership?

The owners of a limited partnership (limited partners) have less liability and are not involved in the day-to-day activities or operations of the company. General partnerships (general partners), on the other hand, have full operational control of the business as well as unlimited liability.

What is double taxation?

Double taxation is when a company is taxed on the corporate level as well as on the individual level. For example, C corporations are subject to taxation on their corporate income, and the owners are also liable for submitting tax on their personal tax returns.

What is a silent partner in a business?

Silent partners have the opportunity to invest money into a business. However, they cannot fulfill or take an active role in the company’s day-to-day operations or management decisions. Therefore, a silent partner’s only contribution is their funding to the business.

What is the definition of a Sole proprietor?

A sole proprietor is an individual who owns and controls a business with no partners involved. A sole proprietor is not a separate legal entity from the business itself and therefore is liable for all the profits and losses from the company.

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