Since the 1990s, a limited liability partnership (LLP) has become a popular form of business organization for many licensed professionals, such as lawyers, doctors, architects, dentists, and accountants. LLPs are creatures of state statutory law and may be formed by two or more partners. Texas became the first state to adopt a law permitting the creation of LLPs and about forty states now formally recognize LLPs. A number of states may limit which types of professions may create an LLP so your state laws will impact whether or not you are eligible to form an LLP. With all of the different types of business organizations to choose from, you may wonder why to choose an LLP over other forms of business entities. Here are some of the key advantages of an LLP.
A main benefit of creating an LLP is a balance of management control with reduced liability exposure. Similar to a general partnership, an LLP permits eligible parties to form a business entity that allows its partners to actively participate in the operation of their business. Unlike general partners, partners in an LLP usually possess some form of limited potential personal liability for the debts, negligence, or wrongdoing of other partners in the business organization. Typically, LLP partners may only risk their capital contributions and do not face unlimited personal liability for another’s mistakes. However, LLP partners are still liable for their individual mistakes or intentional misdeeds, including failing to exercise reasonable care in their professional activities and not properly supervising their employees or agents. An LLP often must carry minimum amounts of liability insurance and/or may be required to post a bond or other form of financial security to help protect the general public from possible liability claims.
In an LLP, each partner has the right to manage the business entity and retain flexibility in shaping their role in business operations. The LLP partners have a great deal of freedom in determining how the LLP will be managed. The LLP partners can agree to delegate daily business operations to a managing partner or to a committee made up of partners. Alternatively, LLP partners may decide to divide up duties based upon expertise, experience, or personal interest. To avoid confusion, it may be useful to develop an LLP agreement to outline each partner’s role in the business.
As stated previously, state law controls the requirements for LLP formation. But generally it is relatively simple for eligible parties to create an LLP. LLP partners often must complete a registration form and file it with the relevant state agency, such as the Secretary of State’s office. State statutes may also allow existing general partnerships to convert their partnership to an LLP. As indicated above, it may be helpful to develop an LLP agreement to spell out each partner’s roles and to identify each partner’s financial contributions and attendant profits and losses.
Typically, the LLP shares the limited liability of a corporation, but avoids the double taxation associated with a corporation under IRS rules. Each partner files their share of LLP profits and losses on their individual federal tax returns. As independent professionals, LLP partners normally pay self-employment taxes. For tax purposes, an LLP is often not taxed as a separate business entity under federal tax laws. Yet certain state statutes may not permit pass-through taxation and may impose a state franchise tax on the LLP business entity. Your local tax professional can help you sort out these complex tax issues.
To find out about creating an LLP in your state, contact your Secretary of State or similar regulatory authority to find out more about your eligibility to create an LLP.