LLP vs LLC: differences, tax benefits, pros and cons

Comparison of the differences between LLP vs LLC, their similarities, advantages and disadvantages of LLC vs LLP and their associated tax benefits.

Owners are still liable for their own negligent acts, malpractice, and liabilities related to their ownership of the firm. LLP is more flexible than a regular corporation or partnership because it is not required to follow some of the strict rules that state how corporations must be managed and operated.

What is LLC?

Limited Liability Company is a legal structure created by the laws of different countries for various business purposes. It usually contains elements of corporation and partnership structures. In LLC, members or company owners are not personally responsible for the company’s obligations and debts.

LLC is one of the most popular types of businesses today, largely because it offers limited liability protection to all its members. In case of a lawsuit, only the company’s assets can be used as compensation for damages and debts. Unlike a sole proprietorship or a basic partnership, where each owner has unlimited liability, LLC protects its owners from being responsible for the company’s activity beyond their investment.

LLP vs LLC chart

Similarities and Differences between LLP vs LLC Chart
Similarities and Differences between LLP vs LLC Chart

Should I form an LLC or LLP?

Many small business owners wonder whether to form a limited liability partnership (LLP) or limited liability company (LLC). They are both popular options for many entrepreneurs. Which is better? It depends on the number of people in your organization, the amount of investment dollars you have, and how much business experience you have under your belt. If you don’t want any mistake arising from the company affecting your personal assets, then go for an LLC. If you want more flexibility in the running of your business then form an LLP.

You have to let go of some advantages of one over another but you cannot get all the benefits from both. We will talk more about LLP vs LLC differences and the advantages so as to make the right choice in starting your business.

Should I hire a lawyer when deciding between LLP vs LLC?

Yes, it is a very good idea to get a business attorney or a tax professional when deciding between LLP vs LLC. Such a business attorney should be versed in state laws where you intend to establish your business entity.

Limited Liability Partnership vs LLC Similarities

  1. They both protect their members from being held personally liable for business debts and claims of business-related lawsuits against the company.
  2. Both are considered pass-through tax entities which means that all profits, losses, and tax obligations are passed through to each of its members. There is no double taxation as is the case with corporations. Periodic distributions to members are not taxed as earned income because they’re not considered self-employment income according to IRS guidelines.
  3. Depending on state laws, an operating agreement may be required for each entity or it can be determined by default under state statutes.

LLP vs LLC differences

The main difference between a limited liability partnership and a limited liability company is that an LLP has one or more general partners with unlimited personal liability, while members of an LLC have limited personal liability under the structure. Each state may make slight variations about these differences so be sure to check with your local Secretary of State’s office before opening your doors for business. Other differences between LLC vs LLP can be seen below when it comes to filing income taxes.

LLP vs LLC: Profits and Losses for Partners

Another difference between an LLP and LLC is how profits and losses for partners are handled. Limited partners in an LLP get their share of the business’s profits or losses based on what percentage of the company they own. This means that if there are two equal partners, each owning 50% of the business, then each partner would get 50% of the distributable profits or losses.

On the other hand, whether or not an LLC member gets a share of profits and losses depends on how much money he or she invested into the company. If you are in an LLC, it is important to have this information written in your operating agreement.

Other differences between Limited Liability Company vs Limited Liability Partnership

  1. An LLP files the 1065 tax form at both entity and partner levels where all profits/losses flow down to each individual member owner for their yearly tax reporting on Schedule K-1.
  2. LLC files the 1120 tax form at their entity level with no K-1’s issued while members file 1040 Schedule C forms to show income and expenses for their yearly tax reporting.

LLC versus LLP: Which is better?

An LLC is recommended if you’re looking for great flexibility when it comes to taxation such as filing taxes at both entity and member levels (1120 vs 1040), pass-through taxation where profits and losses flow down to individual members who pay personal income taxes on their respective shares, as well as your choice of having a flat management fee or distribution of profits/losses among members.

Before you compare LLC and LLP, you should first know what you specifically need for your business and also know the nature and type of business. If you’re a sole proprietor and don’t need much in the way of outside investments, go with an LLP because it offers unlimited personal liability for all its general partners. However, if you have several investors who will be funding or investing in your company, then an LLC may make more sense as its members (owners) only lose their investment dollars (not personal assets such as homes, cars, etc.). There is also the issue of administrative hassle to consider.

The general rule is that an LLC makes more sense for larger companies while LLPs are ideal for smaller organizations. That said, people should choose whatever business entity type they feel most comfortable with; it’s your decision after all since you’re the one who will be living and/or working with it. Just make sure that you stay within state rules and regulations if you decide to go with an LLP or LLC so their members don’t risk personal liability lawsuits against them.

LLP vs LLC Pros and Cons

  • If you form an LLP, it means each partner shares unlimited personal liability for any claims made against the organization by other companies or individuals. This structure offers fewer barriers than having to worry about protecting personal assets.
  • LLCs also offer limited personal liability; however members aren’t allowed to collude in order to take advantage of their business strategies when dealing with other companies or individuals. Members who violate this rule face the risk of losing their limited liability status which means they become personally liable for all debts and claims made by creditors against the LLC.
  • An LLP combines the tax benefits of a partnership with the limited liability of a corporation.  Formalities are less stringent than for corporations; thus, LLP’s can be formed more quickly and cheaply than other legal entities.  
  • There is no upper limit on the number of partners in an LLP.

LLP vs LLC Tax Benefits

Limited Liability Partnership (LLP) combines the tax benefits of a partnership with the limited liability of a corporation. The tax benefits of LLP and LLC include the consideration that both are pass-through tax entities, which means that all profits, losses, and tax obligations are passed through to each of its members.

Another of the LLC vs LLP tax advantages is that there is no double taxation as is the case with corporations. Periodic distributions to members are not taxed as earned income because they’re not considered self-employment income according to IRS guidelines.

How is an LLP taxed?

A major difference between LLP and LLC is how the owners are taxed. When filing taxes for your own company as a partnership, owners must report their share of the business’s profits and losses on their own individual tax returns. This is different from having a corporation that reports its own income, thereby shielding the owners from being taxed twice on the same income.

Just like an LLC, LLP offers some tax advantages to its partners. A limited liability partnership (LLP) is given the tax benefits of both a corporation and a partnership. LLP can deduct its operating expenses as it would for an LLC, but with the additional benefit of not having to file separate federal income tax forms when filing with your state after-year-end report.

When filing, LLP’s partners do not pay individual tax on their share of the business’s revenue but do pay self-employment taxes (Social Security and Medicare) like an LLC.

What to consider for LLP vs LLC taxes

  • A limited liability company, as is the case with limited liability partnerships, is created by filing articles of organization and an operating agreement with the applicable Secretary of State office.
  • With either legal structure, there are minimal formalities involved for conducting business so they’re both easy to set up and maintain. You can file online or on paper depending on what state you live in.

These are some additional things you may want to consider before deciding on a legal structure for your company

  1. If you go with an LLP, be prepared for partnership taxes where owners must pay self-employment tax on a portion of earnings each year based upon their share of equity in the company. This is a good option for people who want to share the risk of owning a business with other individuals.
  2. When you go with an LLC, business owners have more freedom on how they want to distribute membership interest in the company which includes transferring or selling equity stakes as well as splitting profits and losses evenly among members on their personal tax returns.
  3. An LLP is a good choice for small businesses that may not end up needing much outside investment capital since its general partners are personally liable for all debts and claims made against the firm by creditors.

Documentation requirements for LLP vs LLC

  1. An LLP files the 1065 tax form at both entity and partner levels where all profits/losses flow down to each individual member owner for their yearly tax reporting on Schedule K-1.
  2. LLC files the 1120 tax form at their entity level with no K-1’s issued while members file 1040 Schedule C forms to show income and expenses for their yearly tax reporting.

How to form an LLP

The first thing you need to do to form an LLP is to file a certificate of organization. This document needs to include the name, address, and purpose of the limited liability partnership as well as the names and addresses of all partners involved. The total number of partners must be stated as well as their capital contributions. In some states, only one partner is required to file the certificate of organization. Once this document has been filed with the state, then the business becomes an LLP automatically.

LLP vs LLC: How to form an LLC

When you want to form an LLC, you need to file articles of organization with your Secretary of State’s office in order for it to be recognized. In this document, you need to include the name of your LLC, its purpose, and where it is located. You also have to indicate how many managers or members the company will have as well as their names and addresses.

Why would you choose an LLP over an LLC?

When it comes to choosing between an LLP and LLC, the best choice for you depends on why you want a limited liability company in the first place. If you want limited liability protection for your personal assets, then an LLP is better because partners face unlimited personal liability. However, if limited liability isn’t important to you and you just want the tax benefits of having limited partners, then an LLC is probably your best choice.

When is an LLP better than an LLC? Why LLP over LLC?

When you’re choosing between an LLP and LLC, it really depends on what your business is and whether or not you personally want to be protected from lawsuits against the company. One of the advantages of LLP over LLC is that it has personal liability protection; therefore, if personal liability protection is important, an LLP is better than an LLC because partners in an LLP face unlimited personal liability for their actions on behalf of the company. However, if you don’t care about personal liability, then an LLC is better because members of an LLC enjoy limited liability.

When is an LLP worse than an LLC?

If you’re concerned about personal liability and want to keep your business as close to a corporation as possible, then the LLP isn’t the right choice for you. In an LLP, all partners have unlimited personal liability and can end up losing everything they own if the business goes under. However, in an LLC, only the business owners who use their capital to invest in the company are at risk of facing a lawsuit for problems that arise from their individual actions. The passive members who did not put any money into the business do not have to worry about personal liability.

LLP or LLC? How to choose between an LLP and LLC

If you’re trying to choose between an LLP and LLC, then there are a few questions that can help you make your decision. First of all, think about what type of business structure you want. While businesses may have some of the same features regardless of whether they are an LLP or LLC, there are some important differences.

An LLP is more like a corporation because all partners have unlimited personal liability. This means that if the company does not have enough assets to pay debts or judgments against it, then all of the partners can lose everything they own personally.

On the other hand, LLCs are more like sole proprietorships or partnerships because members have limited liability. Passive investors can stay out of trouble in an LLC by being only “members” instead of “partners.” However, if you do want unlimited personal liability protection, then an LLP is the way to go.

LLP vs LLC: Is one of these businesses better?

While a Limited Liability Partnership has some definite benefits, an LLC can offer the same limited liability and some other benefits that you don’t get with a partnership. If your business is just starting out and it’s likely to be very small in terms of profits, then an LLP could work for you. However, if you think your business will grow or if it has great chances of making income, then an LLC is probably the way to go.

Businesses often choose to organize themselves into Limited Liability Partnerships when they do not require corporate formalities or double taxation. Other reasons include: avoiding sole proprietorship legal formalities, the flexibility of transfer of ownership interests, limited liability for torts or debts, easier continuity upon the death of a partner.

Whatever your business needs, there is a partnership out there that can work for you.

FAQs on LLP vs LLC

Is LLC and LLP the same?

An LLC and LLP are not the same; they are different legal business entities with different liabilities and regulations.

LLC or LLP which is better?

An LLP is better if you are worried about the liabilities of the companies affecting your personal assets.

What is the difference between LLC and LLP?

The main difference between limited liability company and limited liability partnership is that an LLP has liability protection from personal assets, while an LLC offers only partial protection.

What are the disadvantages of LLP?

A major disadvantage of an LLP is that it has a limited number of shareholders. Others include: LLP’s are more expensive to form than an LLC and another disadvantage is that LLP may face double taxation (on their profits) under certain circumstances that LLCs do not face.

Conclusion

Sadly there is no one-size-fits-all answer for what type of business entity is best for someone’s specific needs since it largely depends upon their business size and how much investment capital they may need in order to grow. Some business owners prefer going with an LLP because they don’t have to worry about protecting their personal assets if things go wrong while others enjoy the flexibility that comes with an LLC. In most cases, though, people do better sticking with either an LLP or LLC rather than trying to mix the benefits of both since they’re meant to be kept separate for easier administration.

When deciding between an LLP vs LLC legal structure, it’s important that you stay within your respective state’s guidelines. The last thing you want to do is risk losing your limited liability benefits by violating state rules and regulations.

A video on the differences between LLP and LLC

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