LLC Vs LLP

What’s an LLC?

An LLC is a type of business structure that legally separates the business entity from its owners (LLC owners are called “members”). This relatively streamlined structure offers protection for owners’ personal assets from business debts as well as fewer formal reporting and recordkeeping requirements than a corporation. LLCs are, by default, pass-through entities when it comes to taxation. That means the company itself does not pay income tax, with profits instead passing through to the owners’ individual tax returns.

However, if they prefer, LLCs have the flexibility to instruct the government to tax them as a C corporation or an S corporation. While some states prohibit certain licensed professions from forming LLCs, this structure is well-suited for a wide variety of businesses.

What’s an LLP?

An LLP is another type of business structure that separates the business entity from its owners (LLP owners are called “partners”). This structure also offers some protection for owners’ personal assets from business debt. While LLP rules and regulations vary by state, states often reserve this structure for businesses that require a professional license or certification (e.g., law firms, accounting firms, and real estate agencies). Because it’s a partnership, an LLP must have at least two owners. An LLP also is a pass-through tax entity, by default, but does not have the option to elect corporate taxation status like an LLC.

Key Differences Between LLCs and LLPs

Formation

While it’s relatively easy to form both LLCs and LLPs compared to corporations, they do have some key differences. For example, some states restrict the type of businesses that may form an LLP while LLCs generally face no restrictions of this type. In fact, a number of states do not allow LLPs at all.

Another difference relates to an LLP’s formation document, which often must list the protected personal assets of each partner as well as the liability protections each partner has if another partner commits a negligent act. This can make the LLP formation process a bit more complex.

Ownership

Some states restrict ownership of LLPs to licensed professionals, such as doctors, accountants, and lawyers. In those states, these professionals may not form a standard LLC. Most states impose very few, if any, restrictions on LLC members, which can include other companies, non-U.S. residents, trusts, and other entities.

While there's no limit to how many owners an LLC or LLP can have, LLPs must have at least two and LLCs may have just a single owner. In addition, LLC owners are called “members” while LLP owners are called “partners.”

Liability

Both LLCs and LLPs offer limited personal liability protection, but this protection is not identical. In an LLC, all members face some liability risk for the actions of other LLC members. In an LLP, partners have general protection from malpractice suits filed against other partners.

Taxation

Taxed as a partnership, LLPs don’t pay income tax at the company level. Instead, LLP profits pass through to the partners, who pay personal income tax on their share. LLCs also may follow this form of taxation, but they have the flexibility to elect taxation as a C corporation or an S corporation if they prefer.

Key Advantages of LLCs and LLPs

The advantages of an LLC vs. an LLP (and vice versa) may ultimately depend on the specific needs of your business. Depending on your state, you might not have a choice between the two. However, some pros of each structure generally hold true regardless of your location. For example, LLCs offer more tax flexibility while the federal government always taxes LLPs as a partnership. As such, an LLC would be a better option if you prefer the tax status of a C corporation or an S corporation. Depending on the state, LLCs also might have slightly less paperwork during the formation process.

When it comes to liability, LLPs sometimes can provide more personal protection than LLCs. In an LLP, partners generally have protection from malpractice suits brought against other partners. In contrast, an LLC member could still be liable for other members’ actions up to the amount he or she invested in the business.

Common Example of an LLC

There are countless examples of LLCs because this structure works well for a wide range of businesses. From a single-member consulting firm to a multi-member landscaping company to a private equity investor, an LLC can offer the right fit.

Common Example of an LLP

LLPs generally cater to a narrower group of professions. In fact, some states limit LLP ownership to licensed professionals. These could include a law firm, medical practice, accounting firm, or real estate agency.

PLLCs: Another Option to Consider

While not available in every state, a professional limited liability company (PLLC) is another potential business structure option. While similar to an LLC, the PLLC structure is designed for businesses that require licensed professionals. This means professionals like doctors and lawyers who work in states that don’t allow them to form an LLC may opt to form a PLLC instead of an LLP for a PLLC’s increased tax flexibility.

Your state’s specific requirements will play a big role in helping determine if a PLLC is the right structure for your business. Consider your specific industry, the level of risk associated with your work, and how many members will need to hold professional licenses. Because PLLCs typically require a bit more effort in terms of organizing and drafting your operating agreement, the amount of work needed to remain compliant with that agreement also should factor into your decision.