What’s the Difference Between LLPs and LLCs?
Registering an LLP with a state is a two-step process in some states. In Texas, for example, the business must register with the state as a partnership or a limited partnership, then it must apply for registration as an LLP. A limited liability company is a business formed by one or more individuals or other types of owners, with few restrictions on ownership. To register an LLC with your state, you must file articles of organization with the state. In addition to registering with your state, you should create an agreement on how the business will be operated. For LLPs, this is a partnership agreement; for LLCs, it’s an operating agreement.
Ownership
Most states require that LLP partners be professionals. California, for example, allows only licensed attorneys, architects, and accountants to become an LLP. Texas, on the other hand, requires only that the LP be engaged in “any lawful business activity.” LLC owners (called “members”) can be individuals, corporations, other LLCs, or foreign entities. Each state has different requirements for who can form an LLC in that state.
Federal Income Taxes
The IRS considers LLPs and LLCs to be pass-through business types, meaning that profits or losses are passed on to the owners on their personal tax returns. In both cases, the business net income is calculated for the year and divided between owners based on their agreements. LLCs and LLPs differ in the forms used to report business income for the year. LLPs and multiple-member LLCs report income on an information return (IRS Form 1065). A single-member LLC reports income on Schedule C of their tax return. LLP partners and multiple-owner LLC members report their shares of business income for the year on individual Schedule K-1s attached to their tax returns.
Liability Protection
Probably the most important reason people choose an LLP or LLC is that it gives business owners limited liability, separating their personal liability from liability for the actions of other owners. Liability for an individual business owner (sole proprietor) or a partner in a partnership is unlimited, and each owner is 100% personally liable for actions of the business. However, if you create and operate your LLP or LLC by the rules of your state, you can have some protection from liability for debts and lawsuits against the business. LLPs give limited liability to every owner, even general partners who participate in day-to-day management. In a similar way, the LLC structure protects all LLC members.
Which Is Right for Your Business?
An LLP might be right for you if you are two or more professionals who want to go into business together and you want to make sure you all have liability protection. There are several alternatives to an LLP for partnerships that want liability protection but don’t meet the requirements for an LLP. One alternative is a limited partnership (LP) that has at least one general partner responsible for managing the company and who has personal liability for the partnership’s debts, as well as one or more limited partners who have limited personal liability. The other is a limited liability limited partnership (LLLP), commonly used for real estate professionals. LLC might be right for you if you want to go into business by yourself but you want a formal business structure that keeps your business separate from your personal activities, and gives you protection against liability for debts and your actions as an owner. It’s also great for small businesses just starting out that don’t plan on seeking investors or going public.
The Bottom Line
Deciding on a business type is a complicated process, and every business is unique. Get help from a licensed attorney in your state to explore the two types of businesses and how they fit with your situation. They can research the types of professions allowed to form LLPs, discuss the specifics of liability in your state, and help you prepare the documents you need. Want to read more content like this? Sign up for The Balance’s newsletter for daily insights, analysis, and financial tips, all delivered straight to your inbox every morning!
