Entrepreneurs, business owners and investors starting new ventures sometimes wonder about the difference between an LLC and LLP choice. But the LLC vs. LLP question doesn’t have to all that confusing or complicated once someone understands how these two entities are created, what legal protections and tax benefits they offer, and when they’re required.
Note: The acronym “LLC” stands for limited liability company and the acronym “LLP” stands for limited liability partnership.
Creating a limited liability company versus limited liability partnership
Both LLCs and LLPs are created by filing articles of organization or formation with the appropriate state government agency-typically the Secretary of State for the state. The paperwork varies, but in general the filed articles name the new LLC or LLP, briefly describe its activities, and provide contact information for the state and other interested parties.
In terms of formation, then, forming a limited liability company usually closely resembles forming a limited liability partnership. And often the articles of formation or organization amount to a simple one or two page form where the organizer of the new entity “fills in the blanks.” To see examples of what I’m talking about here, compare the two filings (See links below) made when one sets up a limited liability company or limited liability partnership in the state of Washington:
Legal Protections Offered: LLC vs. LLP
A limited liability company and a limited liability partnership offer, essentially, the same legal protection. Both entities shield owners from liability related to the operations of the entity. In other words, if an LLC or an LLP engages in some behavior that triggers financial liability, the LLC members and the LLP partners are not liable merely by virtue of their status as owners.
Note: The owners of a limited liability company are called members, and the owners of a limited liability partnership are called partners.
Similarly, if an LLC or LLP breaches a contract and the breach creates economic damages for another party, again the LLC members and LLP partners are not liable merely by virtue of their ownership.
Moving beyond these LLC vs. LLP generalizations, however, you should note that state laws control the particulars of the legal protections offered by limited liability companies and limited liability partnerships. And in some jurisdictions, a limited liability partnership may have or may be required to have one partner whose personal liability is NOT limited.
Difference in Tax Benefits Between LLC and LLP
Let me also make a quick point about the tax benefits and the difference between an LLC and an LLP. In general, both LLCs and LLPs don’t require the business to pay income taxes on its profits, but rather that they just “pass through” or “distribute” the income, deductions and associated tax liability to the owners of the entity. In comparison, a corporation often would pay income taxes on its business earnings. If those earnings are later distributed to an owner, the owner pays tax again. (This is the dreaded “double tax” you hear corporations and their shareholders talk about.)
When an LLC or LLP is Required
One other point should be made about the LLC versus LLP debate: Some types of businesses in some states may not be able to use an LLC (this is probably most common) or an LLP. For example, one of the reasons that the large law firms and large accounting firms are LLPs is that they can be an LLP in every state. But they can’t operate as an LLC in every state.
Just to be picky, professional service firms in most states don’t actually operate as limited liability companies, but rather as professional limited liability companies. But again, when that option isn’t available, a professional service firm that wants to limit its legal liability might need to use either a traditional corporation (if that’s allowed) or a limited liability partnership (if that’s allowed.)