Limited liability companies and limited liability partnerships are two types of business entities popular with small businesses. While both offer limited personal liability protection for owners so members are not held personally liable for business debts and obligations, they are very different. Here’s what you should know about these two entities as you decide the next step for your business.
What is a Limited Liability Partnership?
A limited liability partnership (LLP) is a type of partnership that grants all owners limited personal liability. Professionals usually choose to form an LLP so they will not be held personally responsible for any mistakes or issues with another partner, such as malpractice claims. In an LLP, each partner is protected from partnership debts that arise from professional malpractice claims against another partner.
Limited liability partnerships are designed for professional businesses, and many states only allow professionals like accounting firms and lawyers to form an LLP. Some states, such as California, will not allow licensed professionals to form an LLC, either.
What is a Limited Liability Company?
A limited liability company (LLC) is the most popular type of business entity for small businesses in the United States. An LLC combines the benefits of a partnership with those of a corporation. When you form an LLC, you enjoy the benefits of pass-through taxation just like an LLP which means business profits and losses are passed through directly to owners without the double taxation to which corporations are subjected. An LLC also offers flexible structure options, few ongoing maintenance requirements, and limited liability protection for owners.
LLPs are usually required to file as a partnership for tax purposes. An LLC can choose to file as a partnership, sole proprietorship (if a one-member LLC), or a corporation. Both entities are treated as pass-through entities for tax purposes which means the company is not subjected to taxes; instead, profits and losses are passed through to owners to report on individual tax returns.
All members of an LLC enjoy personal liability protection from actions by the company’s creditors. An LLP can offer the same liability protection, but some states require that at least one partnership member be accountable for financial obligations of the business.
Both entities are formed when formation paperwork is filed with the state. Both allow owners to avoid the strict paperwork and record-keeping requirements of a corporation.
A limited liability company can have one or more members, and members may be individuals, businesses, trusts, or organizations. An LLP is required to have at least two members. All LLP owners must be individuals.
Depending on the nature of your business, you may not have a choice in whether you can form an LLP or LLC. In general, LLCs are best for general small businesses whereas LLPs offer benefits for professionals who want to avoid liability from the professional mistakes of a partner.