If you are starting a new business, the type of business entity you decide to establish will have an impact on the extent of personal liability, how the business is taxed, its management, the level of formality required, and many other factors. There are a wide variety of options, which can make this decision quite overwhelming. Limited liability companies (LLCs) and limited liability partnerships (LLPs) are two business forms that share some characteristics, but also have some important distinctions.
LLCs protect members and managers from personal liability for the LLC's debts and obligations, as well as for any wrongdoing or negligence committed by the other owners or the employees of the LLC. However, it will not protect members from their own negligence or wrongdoing committed in relation to the business.
LLPs provide similar protection from personal liability for the partners. Generally, the partners in an LLP are not personally liable for business debts and obligations. Thus, creditors of LLPs cannot reach the personal assets of the partners and are limited to the assets of the business. In addition, in most states, partners in an LLP are not personally liable for the mistakes or wrongdoing (negligence, malpractice, or misconduct) of the other partners. However, as is the case with LLCs, partners can be personally liable for their own negligence or wrongdoing. The nature and extent of liability protection varies depending upon the state in which the LLP is formed, so it is important to meet with us to verify the scope of the protection in your state.
Note: A limited liability partnership is different from a limited partnership: In a limited partnership, the managing partner(s) are subject to personal liability for the business's obligations. To qualify for limited liability, the limited partners cannot play a role in the management of the business but must be merely passive investors.
In certain limited circumstances, a court may “pierce the veil,” holding the members or partners of LLCs and LLPs personally liable for business debts or obligations: This could occur when the business is merely the “alter ego” of the members or partners, the business form is used to perpetuate a wrong, or there is a need to achieve an equitable result.
LLCs are not typically taxed as a separate business entity; rather, the profits and losses pass through to the members, according to their percentage of membership interest in the business, who report them on their individual tax returns. Like an LLC, an LLP is not a tax-paying entity. Rather, its profits and losses are passed through to the partners according to their percentage shares in the business. The partners pay taxes on their shares at the individual tax rate.
By default, under IRS rules, LLCs and LLPs are treated as partnerships and must file a partnership information return. One exception to this is a single-member LLC, which is treated as a sole proprietorship (note that partnerships must have more than one partner) and does not have to file a partnership information return. Both LLCs and LLPs can elect to be taxed as an S or C corporation if they meet certain qualifications.
Both LLCs and LLPs avoid the extensive recordkeeping and operating requirements imposed on corporations. LLCs typically must file articles of organization providing basic information about the business with a state or local agency and pay a filing fee. This is the act that creates the LLC in most states.
Partnerships are created automatically when two or more individuals engage in a business enterprise for profit. However, partnerships that elect to become LLPs must typically file a registration form with their state's secretary of state to acquire status as an LLP and enjoy limited liability benefits.