Starting a business venture demands several requirements from entrepreneurs. One chief concern is limiting your exposure to personal liability. Two options for protecting your interests are to structure your enterprise as a limited liability partnership (LLP) or as a limited liability company (LLC).
Limiting personal liability is one way a business owner can protect their interests when an accident or damage occurs in the company. This means that individuals will not be held personally liable for paying creditors, shouldering damages, or taking responsibility for injuries that occur in their place of business.
Starting a business and making it an LLP or LLC creates a barrier between the company and the person. These business structures shield each partner from liability in a company.
Now, how do you know which one to use to protect your interests better?
Definition of an LLP
A limited liability partnership is a legal and tax entity that helps business partners reduce liability from their partners’ dealings and actions. It also benefits business partners because it allows them to share costs that increase production.
This business structure makes partners liable for the amount they put into the business. It distributes risk and institutes a division of labor among partners and members. If the business fails or lawsuits are filed against it, creditors and courts cannot go after a partner or member’s personal assets or income.
Law firms, accounting businesses, and wealth managers often use LLPs as a business structure. However, every country or state may have different laws regarding the creation of such entities, so it's best to study local and state laws before creating an LLP.
Start a Partnership Agreement Here
Definition of an LLC
One benefit of an LLC is that it provides partners some protection against business debts and liabilities. Though a partner may be held personally liable, the consequences are only borne by one partner as opposed to all the partners.
These companies are essentially hybrid entities since they have the qualities of a corporation, partnership, and sole proprietorship.
In terms of LLC taxation, it has the same flow-through model as LLPs and C corporations, since profits and losses are filed by individual partners. Under an LLC, partners also pay taxes on them as individuals.
Like LLPs, LLC guidelines vary by state and country. It would be wise to check local laws before creating one.
Start your LLC Operating Agreement Now
LLCs and C Corporations
When comparing a C Corporation vs. an LLC, we know they share some similarities, but how do they differ from each other?
A C corporation or C-corp is a type of corporation with a tax classification that is employed by many corporations. Unlike LLCs, C corporations are subject to double taxation. C corporations use IRS Form 1120, and partners still have to pay taxes on their personal income using their stocks or shares in the business.
LLCs and S Corporations
Meanwhile, when comparing an LLC vs. an S Corp, these two are also similar, but LLCs can have an unlimited number of members and partners. In contrast, S corporations have a limited number of shareholders.
What makes an LLC distinct from an S corporation and a C corporation is the limited liability and taxation it provides its members.
Personal Liability Protection
Both business structures protect members and partners, but there are significant differences between how LLCs and LLPs can protect business owners.
LLP Partners Are Only Liable for Their Actions
While partners in an LLP are only personally liable for their own negligence, they cannot be held accountable for another partner’s mistakes. If they become liable, they only lose their capital investment.
In some states, however, LLP partners can be held accountable for the partnership’s debts. Also, some states require LLPs to have liability insurance or some form of financial security such as a bond.
LLC Protects Members and Partners From Business Liability
An LLC protects members from being responsible for business debts and claims. Creditors cannot sue or go after a partner’s personal assets if the business goes into debt and fails to pay them.
Members and partners only risk their financial investment. Their personal assets will not be affected. However, if a partner or member is convicted of illegal activity, the LLC and all its members can be held liable.
Taxes for LLPs
Just like a corporation, LLPs have the advantage of limited liability but are free from the double taxation required of corporations. This means that an LLP’s income and profits are passed through to its members and partners.
Each partner will file their income tax and include LLP profits and losses equivalent to their shares. LLP partners and members are considered independent professionals and pay individual tax returns.
An LLP is not taxed as a separate business entity and is thus free from federal tax laws. However, each state may have other types of taxes for LLPs, so it’s best to consult with an accountant or tax professional regarding LLP taxes that are required in the state where the business will be established.
Taxes for LLCs
LLCs are treated much like a sole proprietorship or partnership. It all depends on the number of members or partners who invested in the LLC.
Sole Proprietorship LLCs
When it comes to taxation, LLCs with one member are considered sole proprietorship LLCs. This means that only the member is required to file a tax return, while the LLC itself is not required to file a separate business income tax return.
Sole proprietors must report all profits and losses on their 1040 tax return and must attach the following documents to the 1040 form:
- Schedule C to report business income
- Schedule E to report income from investments and commercial properties
- Schedule SE to pay self-employment tax
LLC profits under the LLC’s bank account should also be reported, and proprietors must pay an income tax on them too.
Multi-membership LLCs
These LLCs are treated as partnerships, but each member or partner must pay taxes based on their share of profits or losses through their personal income tax returns. The distributive share of each member is often outlined in the LLC’s operating agreement and is used to help determine how much each individual needs to pay.
An LLC operating agreement is a legal document that outlines the rights, shares, and responsibilities of each partner or member. It also includes the frequency of meetings, how decisions are made, and other guidelines that outline each partner’s responsibility, including their distributive share.
Often the distributive share depends on the member’s percentage interest in the LLC. However, some LLCs use special allocations to share profits and losses among members equally.
No matter how members divide shares, their taxes are assessed based on their entire distributive share. So, each member must still pay taxes based on the total percentage interest they have in the LLC.
This is significant because it enables members to be taxed according to their rightful share in the company, even if some of it is left in the LLC.
Management Structure
In an LLP, the management structure gives partners flexibility. Partners have management roles and responsibilities depending on their investment, skills, or expertise. Often these duties and responsibilities are outlined in a partnership agreement.
An LLC can explore two options when it comes to management. Members can manage their LLC, or they can hire a manager or several managers to look after the LLC’s operations.
As part of their LLC operating agreement, they have the freedom to choose between these two management models. In both cases, they will have to outline the manager’s role, identify decision-making authorities, and flesh out the responsibilities of individual members (if they plan to manage it themselves).
LLP and LLC Business Examples
Both LLPs and LLCs are used frequently, but sometimes the use of one or the other may be more prominent in different industries. For example, LLCs tend to be larger and more well-known, being used in many industries including tech, consumer goods and energy. Meanwhile, fields such as the medical, financial, engineering and legal service fields commonly involve LLPs.
The following table provides some examples of companies you may know with their business structure, as well as what industry they are in:
| Company | Business Structure | Industry |
|---|---|---|
| Deloitte | LLP | Professional Services |
| Local Law Office | LLP | Legal Services |
| Doctor’s Office | LLP | Medical Services |
| Alphabet | LLC | Technology |
| PepsiCo Inc. | LLC | Consumer Goods |
| Johnson & Johnson | LLC | Consumer Healthcare |
Important Factors for the Right Business Structure
An LLC may be the right structure for you if reducing liability and tax flexibility are most important to you. However, you should also investigate local tax regulations since some states tax LLCs significantly higher than LLPs.
There are also instances when the decision isn’t really yours to make. For example, sole proprietors without managing partners can’t become LLPs. In such cases, an LLC is a more realistic option.
Whichever you end up going with, take the time to study and consider the pros and cons of each business structure. Changing your structure after you’ve finished filing it with your state takes a lot of effort, time, and money, so choose carefully.
Helpful Sources:
Limited Liability Company (LLC) - IRS
Starting a business venture demands several requirements from entrepreneurs. One chief concern is limiting your exposure to personal liability. Two options for protecting your interests are to structure your enterprise as a limited liability partnership (LLP) or as a limited liability company (LLC).
Limiting personal liability is one way a business owner can protect their interests when an accident or damage occurs in the company. This means that individuals will not be held personally liable for paying creditors, shouldering damages, or taking responsibility for injuries that occur in their place of business.
Starting a business and making it an LLP or LLC creates a barrier between the company and the person. These business structures shield each partner from liability in a company.
Now, how do you know which one to use to protect your interests better?
Definition of an LLP
A limited liability partnership is a legal and tax entity that helps business partners reduce liability from their partners’ dealings and actions. It also benefits business partners because it allows them to share costs that increase production.
This business structure makes partners liable for the amount they put into the business. It distributes risk and institutes a division of labor among partners and members. If the business fails or lawsuits are filed against it, creditors and courts cannot go after a partner or member’s personal assets or income.
Law firms, accounting businesses, and wealth managers often use LLPs as a business structure. However, every country or state may have different laws regarding the creation of such entities, so it's best to study local and state laws before creating an LLP.
Start a Partnership Agreement Here
Definition of an LLC
One benefit of an LLC is that it provides partners some protection against business debts and liabilities. Though a partner may be held personally liable, the consequences are only borne by one partner as opposed to all the partners.
These companies are essentially hybrid entities since they have the qualities of a corporation, partnership, and sole proprietorship.
In terms of LLC taxation, it has the same flow-through model as LLPs and C corporations, since profits and losses are filed by individual partners. Under an LLC, partners also pay taxes on them as individuals.
Like LLPs, LLC guidelines vary by state and country. It would be wise to check local laws before creating one.
Start your LLC Operating Agreement Now
LLCs and C Corporations
When comparing a C Corporation vs. an LLC, we know they share some similarities, but how do they differ from each other?
A C corporation or C-corp is a type of corporation with a tax classification that is employed by many corporations. Unlike LLCs, C corporations are subject to double taxation. C corporations use IRS Form 1120, and partners still have to pay taxes on their personal income using their stocks or shares in the business.
LLCs and S Corporations
Meanwhile, when comparing an LLC vs. an S Corp, these two are also similar, but LLCs can have an unlimited number of members and partners. In contrast, S corporations have a limited number of shareholders.
What makes an LLC distinct from an S corporation and a C corporation is the limited liability and taxation it provides its members.
Personal Liability Protection
Both business structures protect members and partners, but there are significant differences between how LLCs and LLPs can protect business owners.
LLP Partners Are Only Liable for Their Actions
While partners in an LLP are only personally liable for their own negligence, they cannot be held accountable for another partner’s mistakes. If they become liable, they only lose their capital investment.
In some states, however, LLP partners can be held accountable for the partnership’s debts. Also, some states require LLPs to have liability insurance or some form of financial security such as a bond.
LLC Protects Members and Partners From Business Liability
An LLC protects members from being responsible for business debts and claims. Creditors cannot sue or go after a partner’s personal assets if the business goes into debt and fails to pay them.
Members and partners only risk their financial investment. Their personal assets will not be affected. However, if a partner or member is convicted of illegal activity, the LLC and all its members can be held liable.
Taxes for LLPs
Just like a corporation, LLPs have the advantage of limited liability but are free from the double taxation required of corporations. This means that an LLP’s income and profits are passed through to its members and partners.
Each partner will file their income tax and include LLP profits and losses equivalent to their shares. LLP partners and members are considered independent professionals and pay individual tax returns.
An LLP is not taxed as a separate business entity and is thus free from federal tax laws. However, each state may have other types of taxes for LLPs, so it’s best to consult with an accountant or tax professional regarding LLP taxes that are required in the state where the business will be established.
Taxes for LLCs
LLCs are treated much like a sole proprietorship or partnership. It all depends on the number of members or partners who invested in the LLC.
Sole Proprietorship LLCs
When it comes to taxation, LLCs with one member are considered sole proprietorship LLCs. This means that only the member is required to file a tax return, while the LLC itself is not required to file a separate business income tax return.
Sole proprietors must report all profits and losses on their 1040 tax return and must attach the following documents to the 1040 form:
- Schedule C to report business income
- Schedule E to report income from investments and commercial properties
- Schedule SE to pay self-employment tax
LLC profits under the LLC’s bank account should also be reported, and proprietors must pay an income tax on them too.
Multi-membership LLCs
These LLCs are treated as partnerships, but each member or partner must pay taxes based on their share of profits or losses through their personal income tax returns. The distributive share of each member is often outlined in the LLC’s operating agreement and is used to help determine how much each individual needs to pay.
An LLC operating agreement is a legal document that outlines the rights, shares, and responsibilities of each partner or member. It also includes the frequency of meetings, how decisions are made, and other guidelines that outline each partner’s responsibility, including their distributive share.
Often the distributive share depends on the member’s percentage interest in the LLC. However, some LLCs use special allocations to share profits and losses among members equally.
No matter how members divide shares, their taxes are assessed based on their entire distributive share. So, each member must still pay taxes based on the total percentage interest they have in the LLC.
This is significant because it enables members to be taxed according to their rightful share in the company, even if some of it is left in the LLC.
Management Structure
In an LLP, the management structure gives partners flexibility. Partners have management roles and responsibilities depending on their investment, skills, or expertise. Often these duties and responsibilities are outlined in a partnership agreement.
An LLC can explore two options when it comes to management. Members can manage their LLC, or they can hire a manager or several managers to look after the LLC’s operations.
As part of their LLC operating agreement, they have the freedom to choose between these two management models. In both cases, they will have to outline the manager’s role, identify decision-making authorities, and flesh out the responsibilities of individual members (if they plan to manage it themselves).
LLP and LLC Business Examples
Both LLPs and LLCs are used frequently, but sometimes the use of one or the other may be more prominent in different industries. For example, LLCs tend to be larger and more well-known, being used in many industries including tech, consumer goods and energy. Meanwhile, fields such as the medical, financial, engineering and legal service fields commonly involve LLPs.
The following table provides some examples of companies you may know with their business structure, as well as what industry they are in:
| Company | Business Structure | Industry |
|---|---|---|
| Deloitte | LLP | Professional Services |
| Local Law Office | LLP | Legal Services |
| Doctor’s Office | LLP | Medical Services |
| Alphabet | LLC | Technology |
| PepsiCo Inc. | LLC | Consumer Goods |
| Johnson & Johnson | LLC | Consumer Healthcare |
Important Factors for the Right Business Structure
An LLC may be the right structure for you if reducing liability and tax flexibility are most important to you. However, you should also investigate local tax regulations since some states tax LLCs significantly higher than LLPs.
There are also instances when the decision isn’t really yours to make. For example, sole proprietors without managing partners can’t become LLPs. In such cases, an LLC is a more realistic option.
Whichever you end up going with, take the time to study and consider the pros and cons of each business structure. Changing your structure after you’ve finished filing it with your state takes a lot of effort, time, and money, so choose carefully.
Helpful Sources:
Limited Liability Company (LLC) - IRS
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