Last Updated: August 31, 2021
LLP vs LLC: What sets these two types of incorporated entities apart? Are the differences so significant that one solution is clearly superior? Do you even have access to both of these business structure types?
Imagine a scenario where you’re a doctor running a small clinic with a fellow physician. And one day, your colleague gets accused of medical malpractice. In this fictional situation, the business entity type would determine your liability. If you’re running an LLP business, you would be safe from any prosecutions.
But this is just the tip of the iceberg of all the differences between these two entity types. So let’s check out what else is there!
What Is an LLP?
Let’s start with the limited liability partnership definition!
LLP is an incorporated entity in which either some or all the partners have limited liabilities. In other words, this is a business entity that has traits of both partnerships and corporations.
This type of business structure is also easy to customize to the needs of your partnership. It allows for the liability of each partner to correspond to the investment they’ve put in the business.
While the LLP meaning may differ based on the interpreter, for most entrepreneurs and investors, this is also a way to split the risk. This separation of liability means that the creditors cannot go after the partners’ personal funds in a scenario where the partnership fails. Also, if there are any accusations of professional misconduct, they cannot affect fellow business owners.
How is LLP different from a general partnership?
When defining the LLP, its comparison to a general partnership is just as important as the LLP vs LLC parallel.
General partnerships require no state filing, ongoing state fees, and franchise taxes. On the other hand, they need to obtain business licenses and cover all the costs that go into it.
Unlike corporations, with general partnerships annual shareholder meetings are not mandatory.
An LLP is only allowed in some specific industries. Specialists like doctors, dentists, architects, and attorneys who want to start a practice/firm together, can register as an LLP. In other words, these partners need to be treated as professionals under state law.
One of the most significant limited liability partnership advantages is that it protects specialists from the potential malpractice of their partners.
What Is an LLC?
An LLC is an abbreviation for a limited liability company. It’s an incorporated business type that helps protect the personal assets of owners (members). In theory, it provides an operational structure comparable to sole proprietorships or partnerships. But it allows for liability protection similar to that of a corporation.
With that said, the biggest difference between an LLC and a corporation is the organization. Namely, while every LLC member has a vote on the company matters, in a corporation, this is not the case with every shareholder. In this regard, LLC seems closer to an LLP. It’s also why LLC vs LLP is such a common dilemma.
How is LLC different from sole proprietorship?
Many people are confused about the difference between registering a sole proprietorship and an LLC. The first thing worth mentioning is that, as a sole proprietorship, a single-member LLC is also an unincorporated entity in the eyes of the Internal Revenue System (IRS).
From a liability standpoint, however, there is a huge difference. An LLC has a legal status similar to that of a natural person. So regardless of whether we’re talking about LLC or LLP, these two business bodies are separate from their founders. This means that the entity can own assets, raise a loan, etc. Also, the losses of the business and the losses of the members are not one and the same. So creditors cannot lay claim on the personal assets of members.
LLP vs LLC: What’s the Difference?
To understand the differences between these two types of business entities, we need to make a quick comparison between their most essential characteristics. These are:
|Formation||It involves picking a trade name, designating a registered agent, making partnership agreements, and applying for licenses.||It involves picking a trade name, designating a registered agent, making an operating agreement, and applying for licenses.|
|Ownership||Owners are referred to as partners.||Owners are referred to as members.|
|Management||Partners manage the business directly.||A managing member runs the business, and each member has a vote.|
|Annual costs||Flat fee per partner (depending on the state).||Flat fee (depending on the state).|
|Separating finances||The partner’s investment in the business determines their liability (one of the main benefits of a limited liability partnership).||A clear legal distinction between personal and business assets.|
|Liability||Limited liability towards collective debts and legal consequences.||Limited liability of members towards debts of the LLC.|
|Taxes||Pass-through taxation.||Pass-through taxation.|
Now here’s a bit deeper analysis of these defining factors to further illustrate the difference between LLC and LLP:
Wondering how to start an LLC? Many first-time entrepreneurs choose to hire LLC services to facilitate the process. Here we’ll cover the basics. The formation steps are fairly similar to those of registering an LLP.
Both incorporated entities need to start by choosing a trade name for their organization. From there, they have to file articles of organization and choose a registered agent. While this may
sound somewhat counter-intuitive, it would be best if a registered agent is not one of the partners or founding members. This is the same for both LLC and LLP and it’s because:
- People who want to separate their private lives from their professional lives may not want to use their home address.
- This address might also change in the future.
- If you decide to register in multiple states, you will need a registered agent for each.
Due to the confusing nature of this requirement, hiring registered agent services might be a safer choice.
The next step is to appoint a manager. Again, you can either choose an outsider or pick a company member and make an LLC operating agreement. In the case of an LLP, you would sign a partnership agreement.
Finally, there’s no difference between a limited liability company and a limited liability partnership when it comes to the necessity to comply with tax and regulatory requirements.
Although an LLC is similar to a corporation, LLC owners are referred to as members, not shareholders. The difference between members and shareholders is that all members have a vote on LLC matters, while not all shareholders have this much executive power.
In LLPs, owners are called partners. Each of them has liabilities that are limited to the amount of their investment in the business. They are also accountable for their own professional conduct. Formally, in the executive sense, there’s not much difference between a member and a partner.
One major difference between LLC and LLP is that you need at least two partners (members) to start an LLP, while with an LLC, you have no such requirement.
Partners completely control LLPs. There are no shareholders or directors, and there are no shares. One of the biggest advantages of an LLP is that it has a flexible internal management structure. Also, if there’s a need for it in the future, it’s quite easy to change the ownership structure, as well as the partners’ rights and duties.
And what is the difference between LLC and LLP in terms of management?
First, note that there are two major LLC management models:
In the case of a member-managed LLC, every manager has the authority to act on behalf of a business. Internally, they will vote on major issues. However, this needs to be specified in an agreement. Member-managed LLCs are simpler, more common, and more similar to LLPs. This is also where LLC versus LLP comparison makes the most sense.
Manager-managed LLCs can designate one member as a manager or hire an outside professional to act in this capacity. So, what is the point of manager-managed LLCs if a member can be a manager, as well? This is only enacted in scenarios where the LLC has some passive members (reluctant to be directly involved in the operations of the LLC in question).
It’s also worth mentioning that many LLCs use the combination of member-managed and manager-managed models. This is possibly the best example of the flexibility and the appeal of LLCs.
One of the most common limited liability company vs partnership comparisons involves the total administrative costs. Since both of these business entities are relatively inexpensive to register, the biggest issues on the list are:
- Taxes (which we’ll discuss later on)
- Annual fees
Here, the scales tip in favor of LLCs, as they pay a fixed cost depending on the state. On the other hand, every LLP partner has to pay an annual fee.
In other words, in the case of an LLC, the total annual fee doesn’t increase with the number of members. This can be turned into a strong argument in any limited liability partnership vs LLC comparison, given that neither LLCs nor LLPs have a limited maximum number of members/partners.
Also, it’s worth mentioning that you have to pay the annual fee for each state that your LLP/LLC is registered in (regardless of how many are there).
Both LLP and LLC provide partners/members with a separation of personal and business assets. One of the biggest LLP advantages lies in the fact that there’s a greater separation between members’ assets.
This will also be a huge issue when it comes to the taxation of partners/members.
In an LLP, partners are usually directly responsible for the management of the partnership. However, they are not liable for the misconduct of other partners. This is why this is a preferred form of incorporation for specialists like lawyers, architects, doctors, etc.
In general, this is applied when:
- The industry depends on the judgment of a specialist
- The consequences can be dire
- A potential error is (almost) an inevitability
This also helps define LLP and the need for the existence of this business structure.
Like in an LLC, the partners are only risking the assets they’ve invested in the enterprise.
The LLC structure provides liability similar to that of a corporation. The members are not personally liable for the business’s debts. As the company is a separate entity, all that’s in danger are the assets that they’ve invested in the company.
In terms of LLP taxation, there’s really not much difference between them and LLCs. Both of these business structures are eligible for pass-through taxation. This is a scenario where the taxes are passed through to members/partners (hence the name).
In other words, the tax is paid through income tax rather than through corporate tax. In this way, members/partners get to avoid double taxation.
LLP Advantages and Disadvantages
Are you still on the face between the two business structures? You may need a summary of the limited liability partnership pros and cons.
LLP is one way for entrepreneurs and professionals to form a partnership with a setup of a limited company. It allows partners to create a separate legal entity, thus restricting their losses or liability for company-incurred debts.
The advantages of LLPs are:
- Liability protection
- Pass-through taxation
- Flexibility of business structure and transfer of ownership
- Intellectual property protection
The disadvantages of limited liability partnership are:
- No flexibility in profit distribution (like with shares)
- Minimum of two members (at all times)
While it’s true that without having two members an LLP wouldn’t even be an option, what would happen if one partner decided to leave? In that situation, the LLP would be dissolved unless a new partner/member agreed to step in.
LLC Advantages and Disadvantages
A major difference between an LLC and LLP is that LLC doesn’t have a limited minimum number of members. Sure, the IRS doesn’t treat LLCs differently than sole proprietorships. But in terms of asset protection and liability, even single-member LLCs are a good choice.
The advantages of LLCs are:
- Liability protection of a corporation
- No minimum number of members
- Offer liability protection to all their members
- Pass-through taxation
And the disadvantages of LLCs are:
- Profits are subject to social security and healthcare taxes
- Difficulty in issuing equity
This last part is particularly troublesome because it’s harder to raise capital. Every member has a vote, which means that with each new person you bring in, you make the management of your LLC somewhat harder.
Bottom Line: Should You Form an LLC or an LLP?
When faced with the limited liability company vs a limited liability partnership dilemma, the first thing worth considering is your occupation. If you’re a licensed professional looking to join forces with a partner, then the chances are that an LLP is the obvious choice.
The LLC structure offers simple incorporation of your business, and it’s a suitable option for small and medium enterprises. LLP, on the other hand, is best for small companies.
In an LLC, if any member makes a mistake on behalf of the company, all members are liable. This is not the case with an LLP. As we’ve already mentioned, malpractice is simply more likely in some industries, and the consequences are more serious. Even a good doctor or a great accountant can make a potentially fatal mistake. In these fields, LLP benefits are simply second to none.
Lastly, when considering legal liability issues, it might be best to consult legal services before making a final choice.
For specialists like accountants, physicians, and lawyers, the LLP structure offers the best form of protection, as members are not liable for the misconduct of their partners. On the other hand, small entities may prefer doing business as LLCs.
In industries where malpractice is both likely and costly, LLP protects a specialist from the mistakes of their partners. On top of this, the partners’ liability is equal to their investment amount. To sum it up, the LLP structure provides liability protection for an incorporated business entity with flexibility similar to that of a general partnership.
The most significant disadvantage of LLP is that it needs at least two members to exist. This means that if one member suddenly decides to leave, the remaining one would either have to find a new partner or see their LLP dissolved. Aside from this, sharing equity in a partnership can be quite inflexible. You can’t issue shares, every new member that you bring in needs to become a partner.
All LLC owners have the same liability protection except for the member-manager, while partners in LLP have different levels of liability protection. Moreover, LLPs are allowed only in some industries and are usually partnerships with specialists like doctors, lawyers, accountants, architects, etc. In other words, before worrying about the LLP vs LLC dilemma, you should first check if the option of registering as an LLP is available in your particular case.