As two common types of business structures in the U.S., LLCs and LLPs both provide liability protection to the owners. The main reason either of these structures is used is to shield the business owner from personal responsibility in the event of a lawsuit against the business. Both are similar, but they also have their differences.
What is an LLC?
LLC stands for limited liability company in which the owners are called members. The members are allowed to manage the business or they can hire professionals to manage it for them. Forming a business as a LLC provides quite a bit of flexibility.
Businesses using the LLC structure can have as many members as they want and they are free from state-mandated management and membership reporting requirements. In addition, LLCs don’t pay taxes. Instead, the profit and losses are passed through the individual tax returns of the members, similar to a partnership. This allows members to avoid what is known as double taxation or taxing both the business and the owner of the business.
What is an LLP?
LLP stands for limited liability partnership. This type of business structure enjoys the same tax advantages as the LLC structure. However, they cannot have corporations as owners and the LLP must have at least one managing partner taking on the liability for the partnership’s actions.
With the LLP structure, the managing partner is in charge and is also legally exposed just as the owners of a business with a simple partnership structure. The silent partners of the business and the investors do receive liability protection unless they take on a managerial role. If they take on any management role, courts may pierce the veil of the liability protection they enjoy.
Most Common Uses of LLC vs LLP
The most common difference between the LLC vs LLP business structure is how they are used and what types of businesses use each structure. Commonly, the LLC is used by small businesses, while the LLP structure is used by larger businesses.
In many states, if a small business has more than one partner, it’s requires to use the LLC structure. LLCs are most commonly used for small to medium-sized businesses with more than one owner due to the benefits provided by the liability protections of the structure.
LLPs, on the other hand, are more commonly used by medical practices and law firms with multiple partners. One partner will be put in charge of running the firms, while the rest of the partners enjoy liability protection. The managing partner or partners often own a larger share of the company compared to silent partners and junior partners.
How is an LLC vs LLP Taxed?
Another key difference seen between LLCs vs LLPs is how each is taxed. LLCs provide flexibility with taxation. They can be taxed as a corporation or they can be taxed with profits and losses passing through the members.
LLPs don’t get the same choices as they are taxed with what is known as pass-through taxation. This means the profits are equally shared among the partners and all partners must report profits as income when filing individual tax returns. This allows the company to avoid paying any federal taxes on their profits.
Restrictions on LLCs and LLPs
Some companies are not allowed to operate as LLCs or LLPs because of the limited liability protection owners gain from this structure. Some of the companies unable to use the LLC structure include:
- Insurance Companies
- Financial Institutions
Some states will also put restrictions on the type of company allowed to use the LLP structure. For example, California and New York will only allow the LLP structure to be used by accountants, architects, engineers and lawyers.
Overall Debate Between LLC vs LLP
One is not necessarily better than the other. LLCs usually fit better for small to medium-sized businesses with multiple partners, while LLPs are used for professional business, such as law firms and medical practices. However, not all states are the same and it’s necessary to check with your state before choosing the right structure for your business.
Choosing between the LLC vs LLP business structure isn’t always an easy decision. If you’re unsure, you may want to consult with an attorney to ensure you form the right structure for your specific situation.