As you start your new business venture, you might explore different business entities that can allow you to be hands-on with business decisions while protecting you from liability. Two options that offer those advantages are:
Before deciding on a legal structure for your business, you should determine what you need and value. While LLCs and LLPs share many characteristics, each business type is different and must comply with its own set of state laws.
An LLC is a business entity with one or more owners, who are known as "members." You can usually create an LLC by filing formation paperwork—usually called "articles of organization"—with your secretary of state.
When properly formed, the business is a separate entity from its owners. So, you can purchase property and open a bank account under your LLC's name. In most cases, your business will also have its own tax identification number (or "EIN").
An LLP is essentially a general partnership—where each partner participates in the business's operations—with the addition of limited liability for one or more partners. A general partnership is formed whenever two or more people do business together, and it doesn't require any legal filings. However, to create an LLP, you must file formal paperwork with the state—similar to the process for starting a limited partnership.
Like an LLC, an LLP is a separate business entity with its own funds, property, and EIN. But be aware that not every state recognizes LLPs. For the states that do, their laws can vary—sometimes significantly.
LLCs and LLPs share many characteristics. They can both offer owners limited liability, tax benefits, and flexible management roles. But on closer look, these business structures differ in meaningful ways.
Both provide limited liability for owners. Both an LLC and an LLP provide their owners with some protection against personal liability, typically reducing each owner's liability to the amount they invested in the business. For example, in this case, if an owner invested $8,000 into their company, then they'd only stand to, at most, lose their $8,000 investment.
Generally, an LLC provides the most liability protection. Except for cases of business mismanagement, the members aren't personally responsible if the LLC is sued or owes any debt. This limited liability serves to protect personal assets like members' houses, bank accounts, and cars.
An LLP has varying limited liability protections. The partners of an LLP might also have limited liability, but the degree of liability protection depends on the state where the LLP was filed. In some states, LLP partners aren't responsible for another partner's negligent acts, but they remain personally responsible for the overall debts and obligations of the business. Other states require at least one partner to have unlimited personal liability, while other partners are protected from business debts and obligations.
Your state's laws can help determine whether an LLC or LLP works best for your company. If your state doesn't recognize LLPs, you can either file for an LLC or look to another state that does accept LLPs. If your state does have LLP laws but the protection for owners is minimal, then it might be best to choose an LLC.
An LLC can opt to be taxed as a:
In contrast, an LLP must file as a partnership.
Sole proprietorships and partnerships are considered "pass-through entities" by the IRS. So, the business's income is passed through to the owners, who report their share of the profits on their individual tax returns.
If the LLC is filed as a corporation, the business first pays tax on its corporate tax return. Then each owner is taxed on their share of the income on their personal tax return. (For more information, read how corporations are taxed.)
Pass-through tax deduction. Owners of both LLCs (that aren't taxed as corporations) and LLPs can take advantage of the 20% pass-through deduction created by the Tax Cuts and Jobs Act. Under this law, you—as the owner of a pass-through entity—can deduct up to 20% of your business profits from your personal tax return. For example, if you made $100,000, you could only be taxed on $80,000 (or 80% of your income). However, there are some limitations to this complex tax break.
If you want to be taxed as a pass-through entity, you'll see many of the same tax advantages in an LLC and LLP. But if you want to choose how your business is taxed, an LLC offers you the flexibility that an LLP doesn't.
Another difference between the two entities is the process for determining the management structure. As mentioned earlier, an LLC can have only one member (known as a "single-member LLC"), while an LLP must have at least two partners.
Both business structures have governing documents that provide rules and procedures for running the company. Both types of agreements provide flexibility and allow owners to choose how each partner contributes and participates in the business.
An LLC is managed according to its operating agreement, which is created by the members. This document outlines:
You can opt to have a member-managed LLC where all of the owners have a say in how the business is run. Alternatively, you can create a manager-managed LLC where you have passive owners or investors who aren't involved in the decision making for the company. (For more information about the differences in LLC management structures, read our article on member-managed vs. manager-managed LLCs.)
With an LLP, the management structure is determined by the partnership agreement. Like the operating agreement, the partnership agreement details each partner's:
You have the option to specify one partner as a "silent partner." Like in a management-managed LLC, the silent partner will receive a share of the partnership's proceeds but won't participate in decision making for the business.
Take time to weigh the pros and cons of each business structure. It's generally challenging—as well as costly and time-consuming—to change the business structure after you've made the state filings. Overall, if your main concern is limiting liability or tax flexibility, an LLC is probably your best option. (For more information, read about the advantages of an LLC.)
However, take a look at your state tax laws; some states might impose a higher tax on LLCs than on LLPs.
In some cases, the decision can be made for you based on the state where you want to file and the type of business you want to have. For instance, if you're running the business on your own without partners, you can't form an LLP.
Additionally, not every state allows you to form an LLP. Moreover, some states only allow professional businesses, like accounting firms and law offices, to use LLPs. Similarly, some professionals might not be allowed to form an LLC, and they instead must choose an alternate structure—like an LLP—for protection.
(If you're considering forming an LLC, read our article on the 6 questions to ask before forming an LLC.)
If you have a good understanding of LLCs and LLPs and you're clear on what your business needs, you can probably make the choice between the two business structures on your own. But if you have questions about your state's business laws or are unsure about which business type is the right choice for you, you should talk to a small business lawyer. They can help you review and understand your state's laws and advise you on whether an LLC or LLP will best benefit you.