If you are a business person, there are various suitable structures that you can select for your business. They include a general partnership, a limited liability company, and limited liability partnership, just to name a few.
In this article, I will focus on LLC vs LLP which is popular among many small business owners (see other ways to fund your company). If you are looking for the best LLC formation service to form an LLC, visit this link. Incfile is a more budget friendly, but reliable service. You can check out how if compares to another LLC registered agent service in our Incfile vs Legalzoom review. Also, if you need online legal assistance, check out our Rocket Lawyer or Nolo reviews.
LLC vs LLP - Which Is Better to Start Your Business?
What is an LLC?
LLC stands for Limited Liability Company. This is a legal and separate entity meaning it can sue and be sued, open a bank account, and operate under its name. Also, companies and businesses - see here what business to start - are pretty similar overall, but you should be aware of the key differences.
It can be owned by 1 or more people (more thoroughly explained here). Its owners are called members who can make decisions about the company. Members can be anyone including foreigners, individuals, members from other LLCs, and even corporations (see how incorporation works).
One advantage of LLC is limited liability protection for its members. This means that under no circumstance they are responsible for the liabilities and debts of the LLC (see also 'Benefits of an LLC').
In order to form a limited liability company or an LLC, you will be required important documents such as articles of organization and operating agreement. On the other hand, if you have decided to purchase a business instead of starting with a clean slate, see this guide.
What is an LLP?
LLP stands for limited liability partnerships. It combines the benefits of partnership and corporation. LLP is mostly preferred by lawyers, accountants, and doctors and we suggest you read more about it in this detailed post.
Many professionals prefer this type of business because it protects them from a lawsuit of their partners.
Another advantage of An LLP is limited liability. Its partners cannot be held responsible for the debts and liability of the business. It protects the personal assets of its partners.
If an LLP is unable to pay its debts, partners cannot lose their cars, houses, and other possessions they might have in order to pay the debt.
I would recommend a limited liability company because it offers limited liability protection for its members, is tax-friendly (see 'When Are LLC Taxes Due?'), and offers flexible management.
You can choose an LLP if you would like extra protection from wrongful acts of your other partners. Among other ways to structure your business, you can opt between a C Corp or S Corp, but also make sure to consult our post on possible forms of a company.
LLC vs LLP Differences in Ownership, Liability, Taxes, and More
Before deciding if your business will be LLC or LLP, it is crucial to know their differences and similarities so you can know the best business entity for your company. Also, it is worth noting , that you can also compare Limited Liability to Incorporated business entities here, in our LLC vs INC review.
Limited Liability Company
Limited Liability Partnership
Protects owners from liability and debts
Protects its owners from liabilities and debts plus from wrongful acts of other partners
Can be formed by 1 member
Must have 2 or more members to form
-Members can be individuals, from other LLCs and corporations.
-The owners of LLC are called members
-The owners can only be individuals, not from other trusts or corporation
-The owners of the LLP are called partners
Offers flexible management. Members manage the LLC.
They can also hire a management team or even choose 1 member to manage the company.
All partners are required to manage the LLP equally
Ease of formation
It is easy to form an LLC especially a single member one
Requires more paperwork for professionals. They need to prove they are qualified to run a licensed profession.
What’s the same about LLCs and LLPs?
Despite their differences, LLCs and LLPs have many similarities and they include:
- Both offer limited liability protection to their owners
- Both pay tax at the individual level (read our tax guide post)
- An LLC and LLP must have a document that contains more information about the businesses such management, profit share, duties of owners, etc. For an LLP, it's referred to as an operating agreement while for LLP is referred to as a partnership agreement.
- Formation fee of both businesses is almost the same.
- They do not have strict formalities and record-keeping requirements
The formation fee of both businesses are almost the same. It will cost you $50 to $500 to form either an LLC or LLP. Annual filing fee for both of them is from $0 to $820 and their tax returns are from $0 to $1,000.
LLC and LLP offer limited protection to their owners. They cannot lose more than they invested in the business in case the businesses fail to pay their own debts. It is important to notice here, though, that angel investors, apart from the funds they bring in, may potentially signal the loss of complete control as an owner.
LLC and LLP are treated as pass-through entities hence are not subjected to double taxation. Only owners pay tax from the profits they get. Additionally, for non profit organizations read our CharityNet USA reviews.
Key Differences between LLC and LLP Businesses
The main differences between an LLC and LLP are:
- LLC can be formed by 1 member while LLP requires 2 or more partners to form it
- LLC offers limited liability protection to its members while LLP offers limited liability protection to its partners plus protects them from wrongful acts of other partners in the business.
- Members can be individuals, from other LLCs and corporations. The owners of LLC are called members. Members for LLP can only be individuals and they are called partners.
- Members manage the LLC. They can hire a manager if they don’t feel like managing the company or can choose 1 member to manage it. With LLP, all partners are required by law to manage the business equally.
- LLCs have few requirements hence they are easy to set up. With LLP, you will need to produce paperwork to prove you are qualified to offer accounting, health or legal services.
Starting an LLC vs. an LLP
How to form an LLC
In order to form an LLC, follow these easy steps:
1. Select the state of formation
It is extremely important to know where you will form your LLC. Forming in the wrong state can result in increase of administrative and formation costs. Select the state that you plan to do business. Alternatively, you can form in a state that has business-friendly laws.
2. Select a suitable name for your LLC
The name must be unique and end with the phrase limited liability Company or abbreviation LLC. It cannot have government names.
3. Select a registered agent
You need a registered agent when setting up your LLC. This person will be receiving important documents and notices on your behalf.
In order for someone to qualify to be a registered agent, he needs to be 18 years and older, have an address in the state that you want to form your business and must be available during working hours in order to receive business documents.
4. File important business documents
Crucial business documents needed to form an LLC includes LLC operating agreement and articles of organization. An LLC operating agreement contains crucial information about the LLC such as how it will be run, how profits and losses will be shared and contributions of members.
Articles of organization contain basic information of the LLC such as address, name, purpose of the LLC, name of the registered agent and state whether it will be managed by members or by a management team.
5. Get an EIN
EIN stands for an employer identification number. You will need this number if you intend to open a business bank account - see which banks are best for small business - and plan to hire employees.
How to form an LLP
An LLP is perfect for a professional service firm with 2 or more partners. It is popular among architects, doctors, accountants, and lawyers.
1. Verify qualification Status
Verify with your state if there are limitations on LLP that you want to set up. No need to spend a lot of time forming your business and then discover that your state allows LLP to just lawyers and accountants.
2. Select a suitable name for your LLP
Select a unique name for your business. It should not be similar to that of another LLP and must end with limited liability partnership or abbreviation LLP.
3. File for important business documents
The documents needed to form an LLP include the articles of organization and partnership agreement. The articles of organization contain basic information about the LLP such as its address, name, and members.
The partnership agreement contains detailed information about how the partnership will be run plus duties of each partner.
4. Seek the services of a registered agent
An LLP must have a registered agent who will be receiving important legal documents on behalf of the partners. The agent must have an address in the state that you want to form your LLP.
5. Get an EIN
Get an employer identification number if you plan to hire employees and open a business bank account. Finally, obtain the required business licenses for your business - see here. Some states may not require a business license.
Ownership of LLCs vs. LLPs
Owners of a limited liability company are called members while limited liability partners are called partners. LLC can be formed by 1 member but LLP cannot.
LLCs can have unlimited number of members, and members can be from other LLCs, trusts, professionals and even from corporations. For LLPs, owners can only be individuals, not other trusts or corporations.
In Some states, LLP formation is limited to certain professionals such as lawyers, doctors, architects and accountants.
LLC vs. LLP Taxes
An LLC pays income tax as a partnership unless it chooses otherwise.
It does not pay income tax at the company level. Instead, members pay personal income tax on the share they get from the company. It is worth noting that a limited liability company can also choose to be taxed as a sole proprietorship (see 'LLC vs Sole Proprietorship' article), C Corporation (check out the LLC vs C corporation post), or an S corporation.
If it chooses to be taxed as a C corporation, it will be regarded as a separate tax entity hence it will pay corporate tax and members too will need to pay personal tax. This is always referred to as double taxation.
A business can avoid this by choosing to be taxed as an S corporation. For S corporation, only owners pay tax from the profits they get (see our S Corp vs LLC review).
LLP pays taxes like a general partnership. It does not pay corporate taxes. Instead, partners pay taxes in their personal tax returns.
Liability Protection for LLC and LLP Owners
Limited liability is a form of protection that prevents owners from being responsible for liabilities and debts of their businesses.
Both LLC and LLP offer limited liability protection to their owners. In both types of businesses, owners cannot lose their personal assets in case there is a lawsuit.
It is worth noting that some states require partners in LLP to be liable for the debts of their business. Check with your state if you will be liable for the debts of your limited liability partnership before forming one.
LLP offers extra protection to its partners from wrongful acts of other partners.
Key Advantages of LLCs and LLPs
Many small businesses prefer to structure their business as LLC or LLPs because of their many advantages. They include:
- A limited liability company and limited liability partnership protects its owners from liability
- They also offer the pass-through tax benefits of a partnership. This means the business does not pay income tax at the company level, instead, the owners each pay taxes on their share of the profits they get from the business.
- Both are easy to form
- LLCs do not have restrictions on the number of members it can have plus they can come from other trusts or corporations.
Easy to form
Forming an LLC or LLP is easier than forming a corporation. It takes less paperwork such as registering of business names, filing for important business documents, and applying for an EIN number.
The process of forming your LLC or LLP is made even simpler by some states in that they do not require filing articles of organization.
LLCs and LLPs owners are protected from liabilities and business debts.
If the limited liability company or limited liability partnership cannot pay a creditor such as a lender, landlord, or a supplier, the personal assets of the owners cannot be used to clear the debt.
The only assets that can be used to pay off the debts are the businesses’ assets. Keep in mind that LLPs protect their partners from wrongful acts of other partners.
Compared to a corporation, LLCs and LLPs are not separate from their owners for tax purposes unless an LLC chooses to be taxed otherwise.
They do not pay income tax at the company level, instead, the owners pay personal income tax only.
Also, an LLC is free to choose either to be taxed as a sole proprietorship, partnership, C Corporation, or an S corporation.
Which to Choose–an LLC or LLP?
The best structure for your business will depend on your business goals. Other factors to influence your choice include liability protection, taxation, and management structure, just to name a few.
Take your time to weigh the advantages and disadvantages of an LLC and LLP so you can make an informed choice. Choose a limited liability company if:
- Want limited liability protection
- Want to hire a team to manage the company
- Want to form a company with 1 member or with an unlimited number of members.
- Do not want restrictions on who can join your company
- Want a company that is easy to form
- You do not want to pay tax at the company level
LLP is a special business structure that is created mostly by a group of professionals. They rely mostly on reputation hence prefer to form a LLP that protects them from wrongful acts of other partners.
Choose an LLP if:
- Want limited liability protection
- Are a group of professionals such as lawyers, accountants, doctors or accountants
I would recommend a limited liability company because it is easy to form, it does not pay corporate tax and has no restrictions on who can be a member. It is less complex and requires less paperwork to form.
This is unlike LLP which requires proof to run a licensed profession.