One of the hardest parts of being a business owner is the stress that comes along with it. It can seem impossible to be an expert at running the business side of things along with perfecting your product or service. However, many entrepreneurs choose not to start a company on their own. They may take a business partner that shares the same dream or possesses the skills and experience in areas that they themselves lack. If you find yourself in this position, should you file as a Limited Liability Company (LLC) or a Limited Liability Partnership (LLP)? Below we cover the benefits, differences and use cases for an LLC vs. LLP business.
What Are the Benefits of an LLC and LLP?
There are several different types of business entities to choose from, but LLCs are advantageous for many reasons. LLCs tend to be simpler and more flexible than a corporation with a business structure that combines the pass-through taxation of a partnership or sole proprietorship with the limited liability of a corporation. This basically means that as an LLC, your business will become its own legal entity that has separate debts and legal matters. However, it is important to note that LLCs are still tied to your personal taxes.
Secondly, there are fewer restrictions on profit sharing within an LLC since members can “distribute profits as they see fit,” according to the Small Business Administration (SBA). “Members might contribute different proportions of capital and sweat equity. Consequently, it’s up to the members themselves to decide who has earned what percentage of the profits or losses.”
An LLP is similar to an LLC with many of the same benefits. Just as with an LLC, the partners have their profits and losses passed through to their individual tax returns. In general, both LLCs and LLPs don’t require the business to pay income taxes on its profits, but instead profits or losses are distributed to the owners of the entity.
In either case, “You could split the profits equally, or each partner could receive a base salary and then split any remaining profits. [Remember, in an equal partnership (50-50) neither partner can make a decision without the other’s approval, whereas in a 51-49 ratio, for example, one partner has final authority],” cautions Caron Beesley on FundBox.
How do LLCs and LLPs Differ?
There are benefits and drawbacks when you are considering choosing an LLC or an LLP. While both have the same tax advantages, here are a few differences to be aware of:
- Those who own the company in an LLC are called “members.” Those who own the company in an LLP are called “partners.”
- LLPs must have at least one managing partner who will claim liability for the partnership’s actions; this partner is therefore legally exposed in the same way owners of a simple partnership are. However, silent partners and investors in an LLP possess liability protection if they are not involved in a managerial role. Conversely, the personal assets of every member in an LLC are protected from actions by the company’s creditors or in the case where the company may be sued.
- LLCs are most suited for small to mid-size businesses with a single owner or multiple owners. While LLCs can have corporations as owners, LLPs cannot.
- The most common type of LLPs are professional businesses such as law firms or group medical practices. They usually are formed when a founding partner or group of partners run the firm and then add silent partners who have bought in. Since these junior partners have limited say over the direction of the firm, the LLP protects them from any problems caused by the decisions of the senior partner(s).
While these basic generalizations can help to guide you through your decision-making, it is important to note that state laws vary concerning the legal protections offered by LLCs and LLPs. For example,” some states like Nevada and California allow only professionals such as attorneys, accountants and architects to form an LLP but do not allow the same professionals to form an LLC,” explains Owen E. Richason IV in the Houston Chronicle.