Limited Liability Partnership
A limited liability partnership (LLP) combines some of the best attributes of an LLC with those of a general partnership. An LLP insulates individual partners from the deeds of others in the business and in some states may offer more robust liability protections.
What is a Limited Liability Partnership?
Limited liability partnerships (LLPs) are unincorporated for-profit businesses with two or more owners—all of whom have a degree of limited liability protection. LLPs are similar to general partnerships in that all partners can actively participate in the management of the business. The main difference is that each partner in an LLP is only personally liable for their own professional activities.
So how does this limited liability work? Generally, partners are not personally liable for the debts and liabilities of the business as a whole. And most importantly, a partner is not liable for the actions of other partners. So your partner’s malpractice suit might bankrupt them—but not you.
While commonly known as LLPs, these business types are occasionally referred to as Registered Limited Liability Partnerships (RLLPs) as well.
Why Choose an LLP Over an LLC?
LLCs are super popular, relatively easy to set up, and with the exception of a few states, generally affordable. So why choose an LLP over an LLC? The answer comes down to who and what is protected.
In most cases, members of an LLC, are protected against being personally named in a lawsuit against the business. This sounds great—until you run a dental business and one of the dentist members of your LLC gets sued for malpractice. Instead of the lawyer just coming for your one member, they go after the whole LLC. Generally with an LLP, this wouldn’t happen because the aggrieved party can only direct their malpractice lawsuit toward the negligent dentist. In this way, the LLP does a better job of protecting the partnership and the other partners than an LLC might.
How to Form an LLP
Forming an LLP is similar to forming an LLC. The first step is to verify that your proposed business can actually operate as an LLP. Most states don’t have restrictions on what type of business can be an LLP, but some states states like California, Nevada and New York, only allow certain credentialed professionals such as doctors, accountants, attorneys and architects to operate as an LLP. Once you’ve verified that you can form an LLP, you’ll need to:
- Pick a business name that includes LLP, L.L.P. or Limited Liability Partnership.
- Hire a registered agent.
- File the required paperwork, usually called a Certificate of Limited Liability Partnership, with the state where the LLP will operate.
- Draft a Limited Liability Partnership Agreement, which outlines each partner’s role and responsibilities, the assets they bring to the partnership, and the distribution of profits and losses.
- Apply for any business licenses and obtain any insurance the state or jurisdiction requires.
- Maintain state compliance and pay all associated filing costs and report fees.
LLP vs LLC
LLCs and LLPs are two legal classifications that are common for small businesses. While the names are quite similar, there are a few differences between the two entities. Here’s what you need to know about the difference between LLCs and LLPs and how to choose the business structure that best suits your needs.
Limited Liability Protection
An LLC offers personal liability protection from any debts or lawsuits filed against the business for all members. In contrast, partners in an LLP are generally only personally liable for their own negligence. This means that in an LLP, one partner is generally not held responsible for the bad actions of another partner.
While not complete opposites, there are some slight differences with regards to how each are managed. For starters, an LLC can be formed by just one person, whereas an LLP needs two or more. LLC owners are called members. The LLC has the option to be member-managed or manager-managed. This means that the members can take an active role in the running of the LLC, or they can elect a member or hire a manager to mind the day-to-day activities of the LLC. The manager does not have to be a member of the LLC.
In most cases an LLP operates like a general partnership, where management duties are equally divided between partners. This is why LLPs are so popular in more hands-on businesses like dental and doctors offices. Partners can however, agree to almost any form of management including giving one partner more control over the operations of the business than the other partners.
When it comes to setting up a business structure for tax purposes, an LLC can either be taxed as a disregarded entity, a partnership, a C corporation or an S corporation. An LLP, on the other hand, can only be taxed as a partnership. Similar to most LLCs, LLPs are considered “pass-through” entities in the eyes of the IRS. This means the profits and losses are reflected on the partners’ personal income tax returns while the company itself is not subject to federal corporate income tax.
Limited Liability Partnership Advantages and Disadvantages
As with every business structure, there is no one-size-fits-all solution, and the LLP is no different. There are certain advantages and disadvantages of LLPs, and we list most of the big issues below.
- Simplified Taxation. Since the LLP is a pass-through entity for tax purposes, there is no double taxation like in a corporation. In addition, partners can set up the LLP in most states to only pull profits from the partnership when needed or wanted, allowing partners to ease the tax burden year-to-year.
- Asset Protection. In an LLP, the individual partners are not liable for the debts and liabilities of the partnership as a whole; rather, they are only responsible for liabilities arising from their own conduct acting on behalf of the partnership. In contrast, a partner in a general partnership is fully liable for the debts and obligations of the partnership.
- Flexibility. LLPs offer flexible management roles for each partner. LLP partners can often take an active or passive role in the business, as long as the specifics are stated in the partnership agreement at the outset. The partnership agreement can also be modified to reflect a partner’s changing role within the business.
- Ease of Formation. LLPs are pretty simple to set up, and partners don’t need to jump through as many hoops as they would if they were looking to form an LLC or corporation. All they need to do is register with their respective state, pay appropriate fees, and draw up a partnership agreement and the LLP is basically in business.
- Control. An LLP’s partnership agreement is integral. If an LLP was to operate without one, a partner could enter into business agreements without consulting the other partners, and the LLP would be liable for any agreement. This outsize control issue can be tamped down with an ironclad partnership agreement.
- Limited Expansion. An LLP formed in one state may not have the complete protection afforded to it, or even be able to operate, if it does business in a different state. Some states offer stronger liability protection to LLPs than others. On top of that, while most states allow LLPs to take part in any type of business, some states like California and New York only extend LLP registration to professional businesses like lawyers, doctors, and the like.
- Insurance Costs. Because you are personally liable for your professional activities, you’ll want liability insurance to protect you in the event you are sued. Insurance may even be required, depending on your state and profession. Comprehensive coverage for attorneys, doctors and other high-risk professions frequently costs thousands of dollars a year.
The Bottom Line
One of the major decisions you will make as a new business owner is what type of entity to select. There are pros and cons to every type, and understanding your options is the first step in making an educated decision about whether an LLP, LLC, or some other entity best suits your needs and fits your goals.
Want to see how LLPs and other partnerships stack up against LLCs? Check out our page below: