What is the difference between the different types of corporate structures?
An LLC is a limited liability company, sometimes referred to as a limited liability corporation, and an LLP is a limited liability partnership. Both legal entities are relatively new in the business world, and both share aspects of a corporation and a partnership. However, there are differences between these two business types, some of which are particular to the state the company operates in.
LLCs and LLPs both provide personal asset protection from business debts and liabilities. However, in an LLC the members are not protected from the liability of another member, but an LLP does give this protection. For instance, if an LLC member in an engineering practice makes a client error that is legally actionable, the LLC and all of its members can be held liable. But if a partner in an LLP is legally liable for something, the other partners cannot be held jointly liable.
Both LLCs and LLPs can “pass through” earnings from the business entities to the members or partners to avoid having to file corporate taxes on the earnings and paying personal income taxes on the same earnings, which is known as “double taxation.” The difference is in how an LLC operates and the number of members it comprises.
For instance, a single-member LLC is considered a sole proprietorship, and the IRS taxes the member as self-employed, at 15.3 percent. But LLCs can be formed as S or C corporations and have to pay taxes on the same profits twice. However, LLPs are treated strictly as partnerships, and the partners pay taxes only on the earnings passed to them though the business.
Laws vary by state, but in general LLCs can be formed by any business or persons, while LLPs are generally restricted to professionally licensed individuals. For instance, some states like Nevada and California allow only professionals such as attorneys, accountants and architects to form an LLP but do not allow the same professionals to form an LLC.
There are a few differences in the formation of an LLC and LLP. Both are formed through articles of organization or articles of formation, and each usually is run based on an operating agreement. The differences are in how the members or partners buy in, sell out and add or remove members or partners.
Another difference is what percentage of control or voting share each member or partner is given. For example, if a company has two principal members when it forms, each would likely be given a 50 percent share. But if another principal buys in with an equal share, the two existing members would sell a total of 33 percent of the firm to the new principal so all have equitable shares of 33 percent. Or if a principal retires in a three-person company, the existing two members would buy the shares, or the retiring principal would sell his shares to a new incoming member.
While both LLCs and LLPs have distinct tax advantages, only LLPs provide legal protection from the actions of another partner. A newly forming business should first look at state law to determine which entity is allowable in the state in which it is headquartered, and at state laws regarding personal asset protection for each entity.