Are you interested in learning all the key differences between an LLC and an LLP, some of the most common business structures around the world? Well, look no further – our article will provide a detailed answer to the question: “What is the difference between an LLC and an LLP” and give you an overview of the two business structures. After defining LLCs and LLPs, we’ll go over several different aspects of the businesses, such as management, formation, taxation, paperwork, and ownership, and explore how the two structures compare.
In addition, our article contains a section where we go over some formation stages LLCs and LLPs share in case you’re curious about how the formation process would go.
At the end of our article, you’ll find a detailed FAQ section where we provide some helpful answers related to LLCs and LLPs.
Before we start discussing all the differences between LLCs and LLPs, let’s briefly define them, starting with LLCs.
What Is an LLC?
An LLC, or a Limited Liability Company, is a legal entity that’s entirely separate from its owners. Unsurprisingly, it’s one of the most popular business structures in the US. One of the many reasons why so many entrepreneurs opt for an LLC is because it provides the best of both worlds – it gives its owners limited liability and protection, all the while operating similarly to a corporation.
There are no special regulations as to who can form an LLC – as long as you’re of legal age, you’re llegible to form an LLC.
There are various types of LLCs, such as:
- Domestic LLCs
- Series LLCs
- Foreign LLCs
- Professional LLCs
- Single-Member LLCs
- Multi-Member LLCs
What Is an LLP?
An LLP stands for Limited Liability Partnership. As its name suggests, it’s a type of partnership that functions as a business structure wherein the partners are given limited liability. Just like an LLC, the business is seen as a separate legal entity from its members. It’s a great option if two or more partners are interested in creating a business, but they don’t want their personal assets to ever be in danger. In the case of a liquidation of the business, the partners will remain protected from any creditors.
Traditional partnerships aren’t granted protection from liability, which is one of the main benefits of opting for an LLP instead of a regular partnership.
There are several types of partnerships:
- General partnerships
- Limited Partnerships
- Limited Liability Partnerships
- Limited Liability Limited Partnerships
LLC vs. LLP: Liability
The most important thing LLCs and LLPs have in common is that both business structures offer liability protection for their members and partners. So, what does liability protection entail for each business entity?
When it comes to LLCs, limited liability means that, in the event of a claim, lawsuit, bankruptcy, or any kind of financial loss, the owners’ personal assets won’t be up for grabs. Their personal assets can include anything from cars to real estate.
However, limited liability means something different when it comes to LLPs. Essentially, the partners will be granted limited liability, but only for the actions and decisions of the other partner. However, the partners can still be personally liable in case they make a mistake. It’s also important to note that LLPs have to appoint at least one partner who will bear the official liability for the partnership.
As you can see, the liability protection for LLPs is somewhat limited, but it still offers more safety than other types of partnerships. Additionally, the extent of the limited liability depends from state to state, so it’s important to consider the specific laws of your state when trying to decide between the two.
LLC vs. LLP: Taxation
Another similarity LLCs and LLPs share is their taxation policies.
Both LLCs and LLPs qualify for pass-through taxation – it refers to a type of taxation where the businesses don’t have to pay taxes on an entity level, only individual. Any income that the businesses make is passed through to the owners, which is where this type of taxation gets its name from. The owners/members/partners only have to pay personal income taxes for their share of the business on their personal tax forms.
This doesn’t mean that LLC or LLP businesses don’t have to submit documents to the IRS for taxation. There are still many protocols regarding taxes that need to be followed, which also depend on the state where your business is located.
LLC vs. LLP: Formation
Apart from taxes and limited liability, LLCs and LLPs also have many things in common in regard to their formation process. Here are all the steps that they share and that you have to comply with if you intend on forming either an LLC or an LLP.
Choose a Location and a Name for the Business
The most basic step in forming either an LLC or an LLP is choosing the state and the location of your business.
As we stated earlier, many regulations vary from state to state, so make sure you choose a state that’s aligned with your values and ideas about your business. Additionally, the formation fees differ for each state, so if you don’t have a big budget to work with at the start, consider choosing a state where the formation fees are lower. With that said, most entrepreneurs choose the state in which they live.
The process of choosing a name for an LLC and an LLP is quite similar – you need to choose a name that’s not in use by some other business. To ensure that you are choosing a unique name, you can do a trademark search, search your Secretary of State’s database, or use an online engine. Almost every state allows you to reserve your name for around 3 months. This is useful in case it takes a while for you to gather and prepare the documents required to register your business with the Secretary of State. By reserving your name, you’ll guarantee that it’s not taken by another business in the meantime.
Keep in mind that some states ban certain words from being used in your official business name. If you’re worried about using a word that’s not allowed, you can always check for a list of the forbidden words at your Secretary of State’s office.
Whether you’re forming an LLC or an LLP, chances are your state will require you to include either LLC/Limited Liability Company or LLP/Limited Liability Partnership in your name.
Where they differ in formation, however, pertains to the states where these business entities are allowed in. LLCs are allowed in every state, whereas LLPs are only allowed in select states, while other states like California, New York, Nevada, and Oregon pose strict restrictions for the purpose of the formation of the business.
Choose a Registered Agent
The next step in forming both an LLC and LLP is finding a registered agent. This step is optional in many states, but it can greatly help.
A registered agent is essentially an individual who receives all the important documents for your business on their behalf. It’s an amazing option for entrepreneurs who aren’t (always) available during working hours for various reasons, or those who simply want a professional to be in charge of all their important documents.
The one thing you should keep in mind is that the registered agent must have a physical address in the state where you’re conducting business.
If you’d like to know more about the intricacies of hiring a registered agent, check out our article on the topic.
Create an Operating/Partnership Agreement
LLCs and LLPs require an operating and partnership agreement, respectively.
It’s not mandatory to create an operating or a partnership agreement in every state, but many businesses choose to do so because it can help immensely in clarifying what everyone’s responsibilities in the business are.
These documents include information such as the roles of every member, the profit division, what would happen in case the business gets liquidated, and the process of hiring new members.
Operating agreements can be especially useful in multi-member LLCs because writing down rules that everyone agrees with can spare the members of many future conflicts.
You’re not obliged to hire an attorney or a legal consultant when drafting an operating/partnership agreement, but it’s highly recommended that you do so. After all, you’re handling delicate information and hiring someone would ensure that you include all the important information in your document.
File Formation Documents
Unlike drafting an agreement, every state requires LLCs and LLPs to file formation documents to the Secretary of State’s office. By doing so, you’re registering your new business with the state and making its existence official.
It’s important to note that, in every state, you have to pay certain fees to file your documents. The filing fees vary from state to state – some states are more expensive than others, so we recommend checking their prices before you start the formation process.
The formation documents include information such as the names of every member/partner, the type of management the business will have, and its location.
Register for an EIN (Employee Identification Number)
You need an EIN for both LLCs and LLPs to perform various business activities, such as opening a business bank account and hiring employees.
An EIN is a nine-digit number that’s used on all tax filings for your business, as well as all your business bank accounts.
Obtain any Required Licences
Whether you’re forming an LLC or an LLP, you’ll need to obtain a business permit if your business falls under some of the following categories:
- Real estate
- Cleaning services
- Insurance agents
If you need more information about whether you’ll need a business permit or a licence, check out the Small Business Administration (SBA)’s website.
LLC vs. LLP: Management
LLCs have a very particular management structure that differs from that of LLPs. There are two main management structures: member-managed LLCs and manager-managed LLCs.
Just like the name suggests, member-managed LLCs are managed by the members – they have a say in every decision related to the business and they have an active role in all the operations. For member-managed LLCs, it’s particularly useful to create an operating agreement at the formation stage where all the individual responsibilities of each member will be stated.
Manager-managed LLCs are managed not by all the members, but by a select individual(s) who have all the authority to make decisions regarding the business, while the LLC members contribute a limited amount.
On the other hand, LLPs are managed exclusively by its partners, so they don’t have the option to hire a manager who will be solely responsible for overseeing all the operations of the business and making decisions. The responsibilities of each partner are stated in the partnership agreement. However, as we stated earlier, each partner isn’t responsible for the potential negligence of the other.
LLC vs. LLP: Type of Business
Members of LLCs have more flexibility in terms of what kind of business they can operate, while LLPs have more restrictions in certain states in relation to their business purpose. For example, some states only allow LLP law firms.
Contrary to LLPs, there are rarely limitations on what kind of business LLC owners can form.
Before embarking on the journey of creating your own LLP, it’s essential to double-check that the type of business you’re planning on conducting is permitted in your state.
LLC vs. LLP: Paperwork
If you’re not a fan of spending hours sorting paperwork, then an LLP might be the better option for you. Generally speaking, LLPs require significantly less amount of paperwork than LLCs, especially during the formation stage of the business. LLCs are more complex and structured than LLPs, so it makes sense that they would have more paperwork on an annual level too.
LLC vs. LLP: Number of Owners
Lastly, let’s discuss the differences in the minimum number of LLC and LLP members.
LLCs can be single-member, so you’re not obligated to find a partner if you want to create an LLC. On the other hand, LLPs automatically entail the existence of two or more partners, so they’re a great option for entrepreneurs who love working in a team.
What Is the Disadvantage of LLP?
LLPs have a few disadvantages and it’s important to consider them before attempting to form one. The main disadvantage associated with LLPs is that you’re completely reliant on your business partner and you have to consult them prior to making any kind of decision. Additionally, all the profits have to be shared among you. In case your partner decides to leave the business, you might be obligated to dissolve it.
Who Controls an LLP?
LLPs are operated and owned by its members. In terms of management, it’s very similar to how general partnerships operate. The members of the LLP are responsible for the day-to-day decisions of the business and all the management-related decisions.
Is LLP Good for a Small Business?
Yes, LLPs are a great business structure for small businesses that don’t have a large budget to work with at the beginning.
Is an LLP a Limited Company?
No, LLPs and Limited Liability Companies (LLCs) are completely different business structures; however, the partners of an LLP are granted limited liability to a certain extent.
A Word of Farewell
We hope this article helped you understand the difference between an LLC and an LLP and that now you can easily decide which one of these business structures would suit you better.
Generally speaking, LLCs are a better option if you have a larger business, while LLPs are good for smaller businesses with a limited budget. Both business structures provide limited liability to their owners, however, with LLPs, at least one partner has to be appointed who will bear the liability of the partnership. They also share their taxation policies – both business structures have pass-through taxation. Where they differ is in terms of management, number of owners, and paperwork.