You are smart if you are starting your own business (or are already in business) and are considering an LLC vs LLP structure. Both are easy to create, protect the owner from liability and save on taxes. The question is which formation is best suited for you? Here’s a primer in easy-to-understand English that will help you decide for yourself.
What do LLC and LLC stand for?
These are acronyms. “LLC” stands for Limited Liability Company. “LLP” stands for limited liability partnership. So far, so good.
How do you create an LLC or LLP?
You can create either form very easily. Usually you file articles of organization with your Secretary of State for either the LLC or LLP. This is very simple to do. It usually involves filing in a basic 1 or 2 page form. You can do this yourself or hire a firm like LegalZoom to take care of it for you inexpensively. You can also hire an attorney to draw up the paperwork but that can be pricey.
Which offers greater legal protection?
Let’s look at the issue of limited liability of members. Both the LLC and LLP offer business owners attractive legal protection. Both will protect you from business liability or from the personal acts of other partners or members. That is similar to the protection offered by a corporation and it’s a good thing. In short, if others are hurt financially as a result of your LLC or LLP’s business dealings, you won’t be held personally liable just because you are a member of an LLC or a partner in an LLP.
The one caveat is that if you open an LLP, some states may require at least one partner to have personal unlimited liability.
What are the tax advantages of the LLC vs LLP?
In general, income from both the LLC and the LLP is passed through to the owners. In other words, neither business formation pays tax on its own. Profits and/or losses pass to the owners. If you form a corporation you aren’t so lucky. Corporations pay tax on earnings and then the owners pay tax again when those earnings are distributed to the owners. Bummer.
Limited liability company tax advantages give it a slight edge. LLPs must file a partnership income tax but LLCs have more leeway. The LLC can file as a sole proprietor (if there is only one member) a partnership or a corporation. That means even though the LLP doesn’t file a federal tax return the LLC may have to if it elects to be file as a corporation.
Keep in mind that you may not be able to form an LLC. That’s because some states won’t allow you to use one form or the other. Here’s why. When you form your LLC or LLP the state in which you file is the “state of formation”. Every other state is thought of as “foreign”. Most states have different requirements for LLCs to do business in but the rules for operating an LLP are usually uniform. That’s why if you plan on opening offices in more than one state you might find it easier to form an LLP.
In order to form an LLP you must have at least two partners and they have to be individuals. An LLC can have as little as one member and as many members as you like. On top of that, the members can be individuals, corporations, trusts or any other entity.
Which is the Right Entity For You?
Now that you have the proper background, you can see that the answer depends on your situation. If shielding your personal assets is the most important consideration, the LLC is going to offer more flexibility. That’s because you won’t be forced to join it as an individual and you don’t need 2 members either.
Also, depending on the state you operate in, the LLP may be required to have at least one individual who is personally liable for the acts of the partnership.
If ease of operation is a concern and you are going to open up offices throughout the country, the LLP will be easier to use. And in terms of tax advantages, the LLC gives you a bit more flexibility as to how you can choose to file.
Smart Next Step
I believe you will be better off if you get expert advice on which business form to use. Buy an hour of your accountant’s time and then an hour of your attorney’s time to discuss this. Once you are clear on which way to go, do the paperwork yourself or use Legalzoom to do it for you. This will save you a good deal of money yet you’ll have the expert opinion you need. And no matter which way you go, make sure to get the right liability insurance for your business.
Which business form are you using? Why?