Entrepreneurs looking to start their new business should be forming a legal entity, and often have to weigh the options of an LLC and a LLP when deciding on the particular business structure. While both provide benefits, they differ in some important ways, and finding which is right for you depends on a number of factors, including you and your business partners’ liability protection and tax considerations. Understanding what each structure provides, and how it differs from the other, can help you make the right choice for your business.
What is an LLC?
A limited liability company (LLC) is a popular business entity with business owners for its flexibility and relative simplicity in both setup and maintenance. Depending upon your situation, you can elect a single-member LLC or an LLC with two or more members. LLCs can be easier and cheaper to form than corporations while offering many of the same benefits, which is why they are the first choice for many businesses.
What is an LLP?
A limited liability partnership (LLP) is a business entity that is formed by two or more owners in partnership with each other. LLPs are a common choice among professionals who wish to pool their talents and resources while still shielding their personal assets and limiting their personal liability. Unlike a general partnership, where no legal entity exists and each partner takes on unlimited liability, an LLP is an actual separate business entity that limits the personal liability of the partners involved in most states. Check with your LegalShield provider lawyer as some states do require at least one partner to have unlimited personal liability.
Differences between LLC and LLP
In deciding between an LLC and LLP, you must first have at least one other potential business partner to consider the LLP. Next, you should look at how they differ from one another to determine the right option. LLCs and LLPs differ on three significant points: how they’re managed; how much liability protection they offer owners; and how they’re taxed (or can choose to be taxed). Depending upon the types of business and the people involved, any of those differences can prove to be a deciding factor or dealbreaker.
Management structure
An important part of any business is the decision making, which is typically the result of the management structure put in place from the start. In an LLC, management is determined by the operating agreement, which sets forth the membership and structure of the company, as well as the roles and responsibilities of each member, and the guidelines for changing the membership.
LLCs can opt for a member-managed LLC, wherein each member has some responsibility for running the business, or a manager-managed LLC, which hands control to one or more members while the others remain passive. Of course, that assumes more than one member in the LLC; many entrepreneurs are looking for complete control of their business, at least in the early days, and unlike LLP, LLCs allow for a single member with total control of the entity and its operation.
With a LLP, the management structure is determined by a partnership agreement, which outlines the roles of each of the partners as well as the financial contributions expected and the profit distributions. In an LLP, one or more partners can choose to be a ‘silent partner’, allowing the other partner(s) to take charge of everyday operations and decision making of the LLP.
Differences in liability protection
Protection against personal liability is one of the most important considerations in selecting a business type and is one of the main motivators in forming an entity in the first place. While both LLCs and LLPs limit the liability of members and partners (hence the name), there are key differences.
With an LLC, members are typically protected against the debts and liabilities of the business, provided that they’ve diligently kept their personal assets separate from those of the business and that none of the members of the company have engaged in illegal activities. That means individual members can’t be sued personally for business debts.
In a LLP, a partner does have personal liability in the case of their own negligence, but each partner is shielded against liability for any negligence on the part of the others. However, depending upon the state, one or more partners may be liable for the overall debts of the partnership itself and other types of liability.
Tax benefits of LLCs and LLPs
Any owner is looking for tax advantages when it comes to choosing a business entity, and both LLCs and LLPs offer tax benefits to its members or partners. For the purposes of taxation, the IRS doesn’t view LLCs or LLPs as business entities, meaning that business profits and losses are passed through to your personal tax return. Whereas LLPs can only file taxes as a partnership, LLCs have a choice when it comes to taxes and can elect to be taxed as a sole proprietorship, partnership, or corporation.
Given that the corporate option means “double taxation”—paying income taxes on both the corporate tax return and personally on distributions from the LLC, tax rates are important and planning becomes quite complex and professional advice should be sought.
Choosing the right business structure
Deciding between LLC or LLP for your business entity is a complex question, and an important one for your new business. You probably don’t have all the answers, but you don’t have to—LegalShield is here to help.
Don’t try to tackle business entity formation without the affordable advice from a provider lawyer available with a LegalShield Small Business Plan.
