If you are starting a new business, the business entity you set up will affect the extent of personal liability, how the business is taxed, its management, the level of formality required, and many other factors. There are a lot of options, which can make this decision overwhelming. Limited liability companies (LLCs) and limited liability partnerships (LLPs) are two business forms that share characteristics, but also have important distinctions.
Similarities
Liability
LLCs protect members and managers from personal liability for the LLC’s debts and obligations, and for any wrongdoing or negligence committed by the other owners or the employees of the LLC. However, it will not protect members from their own negligence or wrongdoing committed in relation to the business.
LLPs offer similar protection from personal liability for the partners. Generally, the partners in an LLP are not personally liable for business debts and obligations. Thus, creditors of LLPs cannot reach the personal assets of the partners and are limited to the assets of the business. In addition, in most states, partners in an LLP are not personally liable for the mistakes or wrongdoing (negligence, malpractice, or misconduct) of the other partners. However, as with LLCs, partners can be personally liable for their own negligence or wrongdoing. The nature and extent of liability protection varies depending upon the state in which the LLP is formed, so meet with us to verify the protection in your state.
Note:A limited liability partnership differs from a limited partnership: In a limited partnership, the managing partner(s) are subject to personal liability for the business’s obligations. To qualify for limited liability, the limited partners cannot play a role in the management of the business but must be merely passive investors.
In certain limited circumstances, a court may “pierce the veil,” holding the members or partners of LLCs and LLPs personally liable for business debts or obligations: This could occur when the business is merely the “alter ego” of the members or partners, the business form is used to perpetuate a wrong, or there is a need to achieve an equitable result.
Tax Treatment
LLCs rarely are taxed as a separate business entity; rather, the profits and losses pass through to the members, according to their percentage of membership interest in the business, who report them on their personal tax returns. Like an LLC, an LLP is not a tax-paying entity. Rather, its profits and losses are passed through to the partners according to their percentage shares in the business. The partners pay taxes on their shares at the personal tax rate.
By default, under IRS rules, LLCs and LLPs are treated as partnerships and must file a partnership information return. One exception to this is a single-member LLC, which is treated as a sole proprietorship (note that partnerships must have more than one partner) and need not file a partnership information return. Both LLCs and LLPs can choose to be taxed as an S or C corporation if they meet certain qualifications.
Formalities
Both LLCs and LLPs avoid the extensive record keeping and operating requirements imposed on corporations. LLCs typically must file articles of organization providing basic information about the business with a state or local agency and pay a filing fee. This creates the LLC in most states.
Partnerships are created automatically when two or more individuals engage in a business enterprise for profit. However, partnerships that choose to become LLPs must typically file a registration form with their state’s secretary of state to acquire status as an LLP and enjoy limited liability benefits.
Both entities may also have to file an annual report with the state. Regardless of which entity you choose, we can help you make sure you are meeting your ongoing responsibilities to the state.
Differences
Business Purpose
Some states limit the use of LLPs to businesses offering professional services, such as lawyers, accountants, or doctors.
LLCs usually can be formed for any type of business. Many states allow LLCs to be formed for any lawful purpose, that is, a specific business purpose is not required. However, a few states prohibit certain licensed professionals from forming an LLC, and others require professionals to form a special LLC called a professional limited liability company.
Because the law varies by state, it is essential to work with us to find out the entities your business is permitted to form.
Management
In most states, LLCs can choose to be member managed, or the members can appoint or hire one or more managers, creating a manager-managed LLC. All the members can take part in the management of a member-managed LLC, although they may choose to alter these rights and responsibilities in their operating agreement. Only managers can manage the operations of a manager-managed LLC. If the articles of organization do not specify that the parties have elected a manager-managed structure, state LLC statutes generally default to a member-managed LLC.
In an LLP, all the partners can take part in the management of the business, as happens in a general partnership. Unlike an LLC, there is no option to hire an outside manager.
We Can Help
The factors discussed above are only a few of the important considerations relevant to choosing the right structure for your business. The decision about which type of business entity to form is complex that will depend on your particular circumstances and the goals you seek to achieve. We can offer guidance about the business structure that will work best for you. Please call us today to set up a meeting.
NOTICE: The information on this website does not constitute legal advice. You should not rely on any information without seeking the advice of a competent attorney licensed to practice in your jurisdiction. This website is both a communication and/or solicitation as defined by California Rules of Professional Conduct, rule 1-400. For further information, please click here.
