Are you thinking about starting a new business with multiple owners? Choosing the correct partnership structure can feel intimidating. Do you go with a standard LLC? Maybe a general partnership (GP) is the best option for you. Or does your situation call for a Limited Partnership (LP)?
But there is another option, the Limited Liability Partnership (LLP). An LLP is a partnership in which all the owners help run the business without the burden of being personally financially responsible for the business’s debts or the actions of other partners.
This guide explores LLPs and explains how LLPs work, how they compare to other structures, and whether this type of partnership makes sense for your business.
Limited liability partnership definition
As mentioned above, an LLP is a partnership between two or more people, but unlike a general partnership, which is unstructured and informal, a limited liability partnership is a formal business structure. That means the partners must register the LLP with the state and comply with specific legal requirements.
LLPs are recognized throughout the United States. However, several states, including New York and California, restrict the use of an LLP structure to licensed professionals, such as attorneys, architects, accountants, and some healthcare providers. Other jurisdictions allow a wide range of multi-owner businesses to form an LLP.
Since the rules for LLPs vary across the nation, it’s essential that you check your state’s requirements before attempting to form an LLP.
How a limited liability partnership works
Before making the decision to register as an LLP, you need to know how they work with regard to ownership and management, liability protection, and tax treatment.
Ownership and management
In general, all partners in a limited liability partnership have an equal say in how the business is run. Of course, this can change depending on the terms of the partnership agreement. A well-written partnership agreement serves as the guiding framework for running the business. Typical partnership agreements cover the responsibilities of each partner, the percentage of ownership, how and when profits are distributed to the partners, voting rights, and procedures for resolving common disputes and occurrences, but some agreements include much more.
Liability protection
Unlike a limited partnership, an LLP typically does not have a general partner with unlimited liability. Instead, subject to state law, partners share liability equally, but their personal assets are protected from the business’s financial obligations. While each partner remains responsible for his own professional conduct, no partner is liable for another’s actions.
Liability protections vary among states, so if your main reason for forming an LLP is keeping your personal finances secure, you’ll want to speak to an expert about the LLP statutes in your state.
Tax treatment
Pass-through taxation is the norm for LLPs. However, in some situations, an LLP can elect to follow the corporate taxation model, but this is uncommon. Under standard pass-through taxation, the company’s profits and losses are generally passed on to each partner in proportion to their share of the company. This setup often requires partners to pay self-employment taxes, but can avoid double taxation.
Limited liability partnership advantages and disadvantages
Like any other business, there are trade-offs with an LLP. Below are a few of the advantages and disadvantages that you need to consider before committing to forming a limited liability partnership.
Advantages
- Partners’ personal finances are protected from the business’s debts and from the actions of other partners.
- Partners share authority in management unless otherwise noted in the partnership agreement.
- Allows pass-through taxation, thereby protecting partners from double taxation.
- Flexible profit distribution structures are permitted under the partnership agreement.
- A great business structure for professional service firms that want to share operational responsibilities.
Disadvantages
- Some states and jurisdictions limit the types of businesses that can form an LLP, such as restricting it to licensed professionals.
- The transfer of ownership interests is less flexible than in other business structures.
- Partners may need to pay self-employment taxes.
- Businesses formed as LLPs are less attractive to outside investors than LLCs.
Since all businesses are different, you’ll need to determine whether the benefits of an LLP outweigh the limitations.
Limited liability partnership vs general partnership
Another form of partnership some companies consider is a general partnership. Although the two structures may sound similar, they are very different, especially with respect to personal liability, the formation process, and compliance requirements. However, both LLPs and GPs share a similar tax situation.
Liability differences
Perhaps the most significant difference between these two types of partnerships is how liability is handled. In a general partnership, the partners’ personal finances are not protected from the business’s creditors or legal liability, unlike under an LLP. In addition, in a general partnership, the actions of one partner can adversely affect all the partners equally. This is not the case in a Limited Liability Partnership.
Formation requirements
General partnerships do not require any formal registration. Simply the act of conducting business with others can constitute a general partnership. On the other hand, LLPs require state registration and come with stricter compliance requirements, including restrictions on the types of businesses that may become an LLP.
Tax treatment
Taxes for limited liability partnerships and general partnerships are usually handled in the same way. Both business structures are pass-through entities by default, although an LLP may choose a different taxation method.
Limited liability partnership vs limited partnership
While a limited liability partnership and a limited partnership (LP) are often confused with each other, there are major differences between the two in how day-to-day management and financial responsibility is handled.
Management structure
Limited partnerships are unequal and must be set up with at least one general partner and one or more limited partners. While each partner in an LLP generally has an equal share in the management and operations, an LP is controlled by one or more general partners.
Liability structure
Although limited partners in an LP do not have a say in the management of the business, the hands-off approach provides them with additional protection against financial and legal liability. While the general partner who manages the business assumes unlimited liability, limited partners are less exposed, with liability often capped at the amount of capital they contributed to the company. Partners in an LLP usually share equal liability.
Typical use cases
The trade-off of less control for less liability makes forming a limited partnership attractive for certain types of business, such as investment ventures and real estate projects. In these types of companies, the limited partners are looking for passive income and don’t want to be bogged down in operational decisions.
On the other hand, partners in an LLP show up at the office each day and are willing to dedicate the time necessary to run the business. For LLP partners, like professional service firms and collaborative partnerships, setting up an LLP is about limiting liability and sharing resources, not diversifying investment portfolios.
Limited liability partnership vs LLC
A limited liability company (LLC) is one of the most popular business structures, but how does it compare with an LLP?
Liability protection
Protecting assets is an attractive benefit for both an LLC and an LLP, but the protections they offer are not always the same. While the extent of financial liability protection is broad and generally the same from state to state for an LLC, this protection can differ when it comes to an LLP depending on the location.
Management flexibility
An LLC gives business owners many more options when choosing a management model. Limited liability partnerships must use a partner-managed management model. Owners of an LLC have the flexibility to choose whether the company is managed equally among all owners or if certain owners have full control over the business operations.
Tax flexibility
Pass-through taxation is the default for both LLPs and LLCs, but an LLC can easily choose to be taxed as a corporation. This change may bring tax benefits, including the elimination of the self-employment tax and the ability for the business to take advantage of certain corporate tax breaks. In some states and situations, a LLP can also change its taxation method, but it is less common and comes with more restrictions.
Ownership and investment considerations
Some states place limitations on the types of business that can form an LLP, but any type of business can register as an LLC. In addition, LLCs are more attractive to outside investors, and transferring ownership interests among owners is much simpler.
When does an LLP make sense?
At the end of the day, licensed professional service providers tend to be a good match for the LLP structure. Lawyers, accountants, consultants, architects, and healthcare providers often work independently but can benefit from shared clients, facilities, and administrative support. Forming an LLP allows these types of professionals to share resources without risking their personal finances due to another partner’s actions.
There are also several other practical reasons why an LLP may not be the best fit for every multi-owner business. Limited liability partnerships are traditionally used by certain licensed professionals, and some states still limit LLP registration to those fields. In addition, LLPs are not a popular business structure for outside investors. While this is fine for professionals looking for protection, not expansion, it isn’t ideal for a growth-focused company.
When does an LLC make sense?
LLCs are the most popular business structure for startups and for good reason. They offer flexible management options along with the liability protection owners want. So, when should you choose to form an LLC?
When broader ownership flexibility is needed
While some states restrict who can register as an LLP, the LLC business structure is much more inclusive. Most states allow any lawful business to use the LLC structure. That includes individuals, entities, and even foreign investors.
When raising outside investment is a priority
Outside investors often prefer working with limited liability companies. Since LLCs are so common, investors already understand how they work and can readily identify a good investment. In addition, the flexibility of the LLC structure makes it easier to modify financial interests within the company.
When liability protection needs to be more standardized
Although some states offer lower liability protection for LLPs, the protection for LLCs remains relatively the same nationwide. If you are located in a jurisdiction with traditional weak protection for LLPs, such as New York or California, choosing a limited liability company may help you sleep better at night.
When tax flexibility matters
A limited liability company offers more options when it comes to its tax treatment. While both an LLC and an LLP typically use the pass-through taxation method, an LLC generally has the flexibility to choose to be taxed as either an S corp or a C corps. Although, in some states and situations, an LLP may also be able to opt for corporate taxation.
Conclusion
A limited liability partnership offers the flexibility of a partnership while providing liability protection, making it a good choice for licensed professionals. It differs from general partnerships and limited partnerships in how liability and management are structured. Although LLPs are recognized in all 50 states and Washington, DC, the requirements and liability protections differ. While LLPs may be a good choice for some businesses, LLCs tend to offer better flexibility and protection.
Before choosing a structure, it’s important to review your state’s rules and consult a legal or tax professional to ensure the best fit for you when you start a business.