LLC vs. LLP: Which Business Structure Is Right for You?

Are you starting a new business and trying to decide between forming a Limited Liability Company (LLC) or a Limited Liability Partnership (LLP)? These popular business structures both offer liability protection, but they have important differences that could impact your business's future. Understanding the difference between LLC and LLP is crucial for making the right choice for your venture.

In this blog, we'll explore everything you need to know about LLC vs. LLP structures, including their key features, tax implications, and ideal use cases.

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What is an LLC?

An LLC is a business structure that combines the liability protection of a corporation with the tax benefits and flexibility of a partnership.

LLCs provide a clear separation between business and personal assets, protecting members' personal property from business debts and lawsuits. This means that if your business faces legal action or cannot pay its debts, your personal assets—like your home, car, and personal bank accounts—are typically protected.

“In general terms, LLCs are owned by individuals called members. They are taxed at the individual level (this is what is referred to as the tax pass-though). LLCs are generally easy to manage, as they do not require officers or boards of directors to run them, and have fewer regulations than other business structures on record keeping and compliance requirements,” says Bill Thrush, Managing Partner of Friedman, Framme & Thrush.

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Key characteristics of LLCs:

• Flexible ownership structure - can be single-member or multi-member
• Pass-through taxation by default, with options to elect different tax treatment
• Limited liability protection for all members
• Management flexibility - can be member-managed or manager-managed
• Fewer formal requirements than corporations

What is an LLP?

An LLP is a specialized business structure commonly used by professionals in fields such as law, accounting, medicine, and architecture.

The LLP structure provides liability protection to each partner from the actions of other partners, though partners remain liable for their own professional negligence.

Key characteristics of LLPs:

• Partnership structure with two or more partners
• Protection from other partners' negligence or misconduct
• Pass-through taxation similar to regular partnerships
• Shared management responsibilities among partners
• Available primarily for professional service firms in many states

Key differences between an LLC and LLP

Understanding the LLP vs. LLC differences is essential when choosing the right structure for your business. Let's break down the main distinctions:

Legal structure and liability protection

LLCs provide comprehensive liability protection for all members, shielding their personal assets from business debts and lawsuits. This protection extends to all business obligations.

LLPs, on the other hand, primarily protect partners from liabilities created by other partners. This means if one partner commits malpractice, the other partners' personal assets are protected. However, each partner remains personally liable for their own professional negligence.

Ownership and management structure

LLCs offer flexibility in ownership and management:

• Can have single or multiple members
• Can be member-managed or manager-managed
• Members can be individuals, corporations, or other LLCs
• No residency requirements for members

LLPs have more specific ownership requirements:

• Must have at least two partners
• Partners are typically professionals in the same field
• All partners usually share management responsibilities
• Some states restrict LLP formation to specific professions

LLP vs. LLC taxes

Both business structures offer pass-through taxation by default, meaning business income passes through to the owners' personal tax returns, avoiding the double taxation that corporations face.

LLC tax considerations:

• Default pass-through taxation (like a sole proprietorship or partnership)
• Can elect to be taxed as an S-corporation or C-corporation
• Members pay self-employment taxes on their share of profits

LLP tax considerations:

• Always taxed as a partnership
• Partners pay self-employment taxes on their distributive share
• Cannot elect corporate taxation

"For 95% of the companies that we are forming for people, we are forming LLCs and then they can elect to have it taxed as an S-Corp or as a partnership. Usually that is a question that we defer to their CPAs on, as the main difference deals with self-employment tax and other expenses," notes Andy Joyce, Partner at Morrow Poppe Law Firm.

When to choose an LLC vs. LLP

The right business structure depends on your specific circumstances, industry, and long-term goals.

Consider an LLC if:

• You want comprehensive liability protection from all business debts
• You need flexibility in management structure
• You want options for how your business is taxed
• Your business isn't in a licensed professional field that typically forms LLPs
• You're starting a business alone or with partners from different backgrounds

Consider an LLP if:

• You're in a professional service industry like law, accounting, or medicine
• You want to partner with other professionals in your field
• You need protection from other partners' malpractice
• Your state allows your profession to form an LLP
• You prefer a partnership management style with shared responsibilities

"An LLP may be a better option if you are planning on pooling together with other professionals, like health care providers, dentists, accounting professionals, etc., and want to be able to maintain the personal liability exposure protection," says Bill Thrush.

Pros and cons of LLCs and LLPs

Before making your decision, weigh the advantages and disadvantages of each structure.

LLC advantages:

• Strong liability protection for all business debts and obligations
• Flexible management options that can evolve as your business grows
• Tax flexibility with multiple election options
• Fewer restrictions on ownership than corporations or LLPs
• Available in all states for virtually any lawful business purpose

LLC disadvantages:

• Self-employment taxes on all profits for member-managed LLCs
• Annual fees and reporting requirements vary by state
• Limited ability to raise capital compared to corporations
• May not be ideal for certain professional services that traditionally use LLPs

LLP advantages:

• Protection from partners' malpractice or negligence
• Professional image in fields where LLPs are common
• Simpler structure than corporations
• Pass-through taxation avoids double taxation
• Equal participation among partners in management

LLP disadvantages:

• Limited availability in some states and for some professions
• Personal liability for your own professional negligence
• No corporate tax options like LLCs have
• Partnership disagreements can be challenging without clear governance
• Less flexible than LLCs for ownership changes

Setting up an LLC or LLP

The process for forming either business entity varies by state but generally follows similar steps.

Steps to form an LLC:

1. Choose a business name that complies with your state's LLC rules
2. File formation documents (Articles of Organization) with your state
3. Pay filing fees which vary by state
4. Create an operating agreement outlining ownership and management structure
5. Obtain necessary business licenses and permits
6. Apply for an EIN (Employer Identification Number) from the IRS
7. Open a business bank account to maintain separation of finances

Steps to form an LLP:

1. Choose a business name that complies with your state's LLP rules
2. File registration documents with your state
3. Pay filing fees which vary by state
4. Create a partnership agreement detailing rights and responsibilities
5. Obtain professional licenses required for your field
6. Apply for an EIN from the IRS
7. Open a business bank account for the partnership

"In Nebraska, we start by meeting with the member, figuring out what type of business they will be doing, how many employees they will be having, etc. Then we check with the Secretary of State to see if the name is available, file the necessary documents to form the company with the Secretary of State and then publish notice with a local paper to adhere to Nebraska statute. We then work with the member on their operating agreement," explains Andy Joyce.

The importance of professional legal guidance

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While it may be tempting to handle business formation yourself to save money, professional legal guidance can prevent costly mistakes.

“We lawyers can help business owners from formation to identifying and preventing employment issues, acquisition of new businesses, dealing with competitors, collections from customers, bringing on new employees, bringing on new partners, and winding down companies,” says Andy Joyce.

Joyce further emphasizes: "By spending time and energy working through those issues on the front end, it can save you thousands of dollars litigating it on the back end."

Bill Thrush agrees on the importance of legal counsel: "One of the biggest misconceptions is that you can do everything yourself. Here is the analogy I like to use to explain why that is not a good idea. If you had a toothache, and need a tooth to be pulled, you could, of course, get a pair of pliers and pull it yourself. It might work. It might not. But it would certainly be messy and unpleasant... Let a professional worry about it."

Conclusion: Making the right choice for your business

The difference between LLC and LLP structures comes down to your specific business needs, industry, and long-term goals. While both offer liability protection and tax advantages, they serve different purposes and have distinct features.

Consider an LLC if you are an individual or if you have multiple members and want comprehensive liability protection, management flexibility, and tax options for a wide range of business types. (Remember that you cannot have an LLP as an individual, so if you are on your own, an LLC is what you want.)

Consider an LLP if you're a professional service provider partnering with others in your field and need protection from partners' actions while maintaining a partnership structure.

Remember that state laws regarding these business structures vary significantly, so consulting with legal and financial professionals in your area is essential before making your final decision.

Bill Thrush advises, “Every single decision made by a small business owner has a legal component to it.  Whether to engage with a vendor, whether to offer certain goods or services to the customer, which contracts to sign or not sign, how to handle employees’ hiring, firing, benefits, and payroll, what insurances to have in place, how to collect accounts receivable, how to pay accounts payable, and the list goes on and on.” This is just one of the many reasons why it is so helpful to consult your LegalShield provider lawyer before you make essential legal decisions with your small business.

Or as Andy Joyce puts it more colorfully: "Your team of accountants, lawyers and bankers are like toilet paper. Quality matters and if you skimp, you'll regret it."

By carefully evaluating the LLP vs. LLC options and seeking professional guidance, you'll be well-positioned to choose the business structure that best supports your venture's success.

LegalShield not only simplifies common legal issues for you, but we’ve also got your back when life throws you a legal curveball. When it comes to dealing with contracts, fine print, business decisions and more, you’re not alone. An affordable LegalShield Membership with our Small Business Add-on gives you access to provider lawyers who can answer questions, schedule consultations, assist with diverse areas of small business law, and offer further services at a 25% discount. Let your provider lawyers focus on the law so you can focus on your business.

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Written by Elyse Dillard, Content Specialist at LegalShield. Elyse creates educational resources about legal and identity theft protection services. She works to make complex legal concepts more accessible to readers and has contributed to numerous articles on the LegalShield blog.

‍Pre-Paid Legal Services, Inc. (“PPLSI”) provides access to legal services offered by a network of provider law firms to PPLSI members through membership-based participation. PPLSI is not a law firm. Neither PPLSI nor its officers, employees or sales associates directly or indirectly provide legal services, representation, or advice. The information made available in this blog is meant to provide general information and is not intended to provide legal advice, render an opinion, or provide a recommendation as to a specific matter. The blog post is not a substitute for competent legal counsel from a licensed professional lawyer in the state or province where your legal issues exist, and you should seek legal counsel for your specific legal matter.