A limited liability partnership (LLP) and a limited liability company (LLC) are two popular legal structures for small businesses. While they sound similar, they have some key differences that founders should know.
Both legal structures combine certain aspects of both corporations and partnerships. However, they have their own management requirements, tax benefits, and liability protections.
Let’s do an LLP vs. LLC comparison to explore the differences between these two business structures.
What is an LLP?
A Limited Liability Partnership, also called an LLP, is a general partnership. Essentially, this means that it is formed by two or more owners, who are referred to as partners.
Perhaps the most significant advantage of choosing an LLP as a business entity is that it affords personal liability protection to business partners. This unique quality of an LLC means that partners aren’t liable for negligence or wrongdoing of:
- Or the business itself
There are no restrictions on the number of partners an LLC can have. Additionally, the responsibility of each partner is determined by the partnership agreement, which lends this business structure a fair degree of flexibility.
Some of the most common forms of LLCs are professional businesses, like medical offices and law or accounting firms. Some states restrict the incorporation of LLCs to licensed professionals, like doctors, lawyers, dentists, accountants, etc. These regulations highlight why it’s essential to check your state rules to see what options are available.
What is an LLC?
A Limited Liability Company, or LLC for short, is a business entity that is frequently favored by small businesses. An LLC is a legal structure that is considered separate from its owners. It provides owners with a blend of the limited liability protection enjoyed by corporations, along with the tax benefits that are associated with a partnership.
The owners of an LLC are generally known as members. As we mentioned above, forming these kinds of business entities protects their personal assets from debt collection or litigation. However, for this protection to stand, members need to keep personal and business funds separate.
LLCs can be formed by either individuals or multiple members. Again, there is no fixed limit on the number of members each LLC can have. Based on the number of members they have and how they choose to operate their business, LLCs have a lot of flexibility when it comes to taxation:
- Single-member LLCs have the choice of being taxed as a sole proprietor, an S corporation, or a C corporation
- Multiple-member LLCs can decide between a partnership, an S corporation, and a C corporation
LLP vs LLC: Similarities
Before we get into the LLC vs LLP key differences section, let’s take a look at how these business structures are similar. They have a lot more in common than just the first two letters of their acronym.
Here is a quick rundown of LLP and LLC similarities.
- You need to file paperwork and pay fees to form either entity
- Forming either entity requires the inclusion of a legal document that details how the business will be run. For LLCs, it’s called an operating agreement; for LLPs, it’s known as a partnership agreement.
- Both entities can have as many members or partners as it chooses
- Both LLCs and LLPs are considered pass-through business entities. This categorization means that profits or losses are reported on the owner’s personal income tax returns
- In general, both structures provide protection from personal losses as a result of business failure.
OK, so now that you know how they are alike, let’s do an LLP vs. LLC comparison to show how each entity is different.
Three main differences between LLPs and LLCs
To help you in your LLC vs LLP comparison, here are the three main differences between the two structures.
1. Limited Liability Protection
An LLC provides its members with personal protection from liabilities like debts and lawsuits. An LLP also protects partners from liabilities. However, there are some notable differences between the two structures when it comes to liability protection.
LLC members have personal liability protection from a)debts and b)claims made against the company. So, if your business owes money, a creditor can’t sue you for your personal assets, like your home.
If you open an LLC, all that you stand to lose in the event of a problem is the amount of money that you’ve invested in starting and running the business. However, there are some situations where this liability protection doesn’t apply, such as negligence via fraud or misuse of company funds.
On the other hand, in an LLP, each partner is liable for their own business obligations but not for their partners. However, this varies from state to state. In some states, an LLP offers the same protection as an LLC.
So, before you open an LLP, check your state’s statutes so you know if you’ll be responsible for your partner’s obligations.
Some other LLC vs LLP differences exist on a state level are:
- Some states mandate that each LLP designate a fully liable partner while affording the other partners limited liability
- Some states demand that LLPs purchase liability insurance, while others require a security bond for doing business
2. Management structures
LLC owners are called members. An LLC can be structured in two different ways:
A) Member-managed: where LLC members manage the business themselves
B) Manager-managed: Where LLC members appoint a member or non-member to manage the business
One of the most attractive aspects of an LLC is its management flexibility. How you structure your management and decision-making can be defined in the Operation Agreement, which sets out the rights and responsibilities of each member.
On the other hand, LLP owners — which are referred to as partners — use a partnership agreement to define things like:
- Duties and responsibilities
These agreements afford partnerships a high degree of flexibility and customization.
3. Tax structures and filings
The final significant LLC vs LLP difference comes in how each business can be taxed.
But first, let’s look at how LLCs and LLPs are similar in terms of taxation. The IRS doesn’t recognize LLCs or LLPs as business entities. As a result, neither business structure has to pay income taxes. Instead, they are required to file what is known as an informational tax return.
Now, for the differences.
LLCs can be structured in different ways for tax purposes. They can be taxed as:
- Sole proprietorship
- C corporation
- S corporation.
LLCs can decide to file corporate tax returns. If they don’t, they are taxed as partnerships. If an LLC files as a partnership, it can avoid double taxation. Double taxation occurs when a business:
a) pays corporation tax on its earnings
b) business owners pay personal income tax on these same earnings.
If you form a one-person LLC, it is considered a sole proprietorship for tax purposes. As a result, you have to file self-employment taxes. Additionally, there are specific situations where federal laws require specific LLCs to file tax returns as a corporation.
On the other hand, an LLC can only be taxed as a partnership. The IRS views partnerships as “pass-through” entities. This means that the business profits and losses are reported on the partners’ personal income tax returns. The company itself isn’t required to pay taxes.
Advantages of an LLC
There are a lot of advantages to forming an LLC. Here are some of the most important benefits that you should consider.
You only need one member to form an LLC:
Having a business partner works for some people. However, others prefer to go it alone. An LLC makes that possible while still providing more protection than a sole proprietorship.
Protection of personal assets:
Things go wrong in business. For example, you can go bankrupt or get sued. An LLC protects your personal assets, like your home, in the event of debts or legal action.
Some states, like Delaware and Wyoming, allow the formation of Anonymous LLCs. This feature will enable members to keep the details of their business ownership private.
LLCs offer founders the option of being taxed as a corporation or as a pass-through entity. This setup allows owners to avoid double taxation.
Advantages of an LLP
Easy to set up:
While an LLP is more complicated to set up than a standard partnership, they are generally considered easy to incorporate.
Protection from partners:
Starting any business carries some risk. However, one of the biggest things that can go wrong is when your partner makes a mistake. An LLP protects you from losses that result from your partner’s negligence.
However, in some states, you can still be responsible for your partner’s actions. So ensure you check before going into business with anyone.
Management structure flexibility:
The final advantage of an LLP is its flexible management structure. Essentially, LLPs work similarly to general business partnerships. However, you can draw up a partnership agreement to determine how business decisions are made.
LLC vs LLP?: Which one should I go for?
So, now that you have a good idea of what LLCs and LLPs are about, it’s time to think about which one is best for you. The short answer is it depends on your personal circumstances and preferences. Let’s explore some different scenarios to help you in your decision.
How many founders?
One of the most straightforward and apparent fault lines in the LLC vs LLP battle can be found in how many people are involved in your business. If you are starting a solo venture where you’re the only founder, you can’t start an LLP because they require one or more partners. This restriction is one of the reasons why an LLC is one of the most popular types of business structures for small businesses.
What are your local state regulations?
Another point to consider in an LLC vs LLP standoff is that some states don’t recognize LLPs. Other states only allow specific types of business to be an LLP, such as accountancy practices or law firms. Additionally, certain professions aren’t allowed to form an LLC in some states and instead need to form an LLP. So always find out the rules in your state or the state where you plan to incorporate them.
How important are limited liability and tax flexibility to you?
Finally, if your main concern when incorporating a business is to benefit from limited liability and tax flexibility, an LLC is definitely your best option. Unfortunately, not all companies work out, so it’s vital to protect your assets from creditors in the event of debts or litigation.
An LLC provides more liability protection than an LLP, which largely protects each partner from losses as a result of their business partners’ actions.
Overall, we believe that an LLC is the better option because of its superior liability protection, tax flexibility, and the fact that the business structure is open to solo founders. If you are starting a small business, these are all compelling reasons to choose an LLC.
How to set up an LLC?
When it comes to opening an LLC, doola is your best option. We help founders incorporate US-based LLCs whether they are living in the country or are based abroad.
Starting a company takes time and research. For time-starved founders, doola offers a way to make the process quick and easy. We can help you with the various documents you need to form an LLC in the US, alongside assistance getting an EIN. For foreign founders, we can help obtain a virtual address and business bank account.
Our starting package for LLC formation costs just $179 plus state fees. These fees vary from state to state, so check out our helpful guide, How much does it cost to start an LLC? for more details. Our starting price includes a free registered agent for the year, which is a huge saving when compared to some of our competitors.
So when you need to save time and money when forming your LLC, get in touch, and we can help — no matter where you are based.