LLP vs. LLC

What Is a Limited Liability Company (LLC)?

A limited liability company (LLC) is a business formed by filing a certificate of organization with a state's secretary of state. LLC owners are "members," and an LLC must have at least one member.

An LLC differs from a traditional partnership in that its members are not personally liable for the business's debts and obligations. With a partnership, each partner has unlimited personal liability for any business debts.

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What Is a Limited Liability Partnership (LLP)?

A limited liability partnership (LLP) has both general partners and at least one limited partner. Limited partners have a passive role in the overall management of the partnership and are not personally liable for any business debts beyond their investment in the business. General partners are fully liable for any of the business's debts.

While the general partners are responsible for daily business operations and management, a limited partner plays a passive role and has an interest in the overall business that is equal to their share of the partnership's profits.

An LLP is created by the majority vote of the general partners to change the partnership agreement from a general partnership to an LLP, or by agreement of all the partners to do so. The partners then must file a statement of qualification with the secretary of state.

Management Structure of an LLC

An LLC's operating agreement describes the management structure of the company. An LLC is either managed by its members (called a "member-managed LLC") or managed by managers (called a "manager-managed LLC").

The operating agreement should address specific details about management. Such details include:

• Whether the LLC is member-managed or manager-managed
• How profits and losses will be shared
• The members' agreement as to when, and how often, meetings will be held
• What voting powers the members have
• Rights the members have and what responsibilities the members carry
• Number of shares each member can own
• The process of dissolution of the LLC either by a member's sale of their interest, a member's death, or the members' decision to dissolve the LLC entirely

Management Structure of an LLP

An LLP is managed by the terms set out in the partnership agreement. It is good to iron out as many details as possible regarding management initially, and a partnership agreement does just that.

The partnership agreement must include the name of the LLP. Note that an LLP's name must show some indication that it is a limited liability partnership. That means the LLP's name must include Registered Limited Liability Partnership, Limited Liability Partnership or the abbreviations RLLP or LLP at the end of the name.

The partnership agreement should declare what authority each partner holds to bind the LLP to the terms of a contract. If you do not state how much, if any, authority a partner has to bind the LLP, every partner has equal authority to bind the business to any contract.

You should also include details about the overall management of the LLP in the agreement. Finally, it should state how the partners will share profits and losses, how the partnership intends to resolve disputes, and how they desire to bring in new partners or dissolve the partnership in the future.

Taxing an LLC

An LLC is known as a "pass-through entity" for income tax purposes. As a pass-through entity the LLC members avoid double taxation by reporting the business's income (or losses) on their personal income tax returns. The LLC, itself, pays no tax.

Ultimately, pass-through tax treatment by the IRS for LLCs eliminates the problem of double taxation that occurs when a business forms as a traditional C-corporation because members only pay taxes on the business's profits once. C-corporations pay the corporate income tax and then the income is taxed a second time when it is distributed to shareholders.

Like LLP general partners, LLC members are also subject to the self-employment tax that covers their contributions to Social Security and Medicare. ​LLC members and general partners pay self-employment tax on their share of the LLC dividends or the partnership's income. However, an LLP's limited partner generally does not pay the self-employment tax because they are considered passive investors.

Taxing an LLP

An LLP is also a pass-through entity where both the limited and general partners report the business's income on their personal tax returns. The IRS does not treat an LLP as a separate business entity. Therefore, the business itself is not taxed.

You May Need Individual Malpractice Insurance

It is important to remember that for both an LLC and an LLP, the members and the partners should have individual malpractice insurance coverage. The personal liability protection that both an LLC and an LLP provide does not extend to the members' or partners' own negligence.

Additional Questions About LLCs and LLPs?

If you are starting a business and have questions about whether it should be structured as an LLC or LLP, an experienced local business attorney can help. Choosing the right business structure can ensure that you will not be liable for the business's debts and achieve the maximum possible tax savings.​​

Internal Links:

• Making LLC Operating Agreements
• Write a Partnership Agreement