If you are starting a new business, the type of business entity you decide to establish will have an impact on the extent of personal liability, how the business is taxed, its management, the level of formality required, and many other factors. There are a wide variety of options, which can make this decision quite overwhelming. Limited liability companies (LLCs) and limited liability partnerships (LLPs) are two business forms that share some characteristics, but also have some important distinctions.
Similarities
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Tax Treatment
LLCs are not typically taxed as a separate business entity; rather, the profits and losses pass through to the members, according to their percentage of membership interest in the business, who report them on their individual tax returns. Like an LLC, an LLP is not a tax-paying entity. Rather, its profits and losses are passed through to the partners according to their percentage shares in the business. The partners pay taxes on their shares at the individual tax rate.
By default, under IRS rules, LLCs and LLPs are treated as partnerships and must file a partnership information return. One exception to this is a single-member LLC, which is treated as a sole proprietorship (note that partnerships must have more than one partner) and does not have to file a partnership information return. Both LLCs and LLPs can elect to be taxed as an S or C corporation if they meet certain qualifications.
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Formalities
Both LLCs and LLPs avoid the extensive recordkeeping and operating requirements imposed on corporations. LLCs typically must file articles of organization providing basic information about the business with a state or local agency and pay a filing fee. This is the act that creates the LLC in most states.
Partnerships are created automatically when two or more individuals engage in a business enterprise for profit. However, partnerships that elect to become LLPs must typically file a registration form with their state’s secretary of state to acquire status as an LLP and enjoy limited liability benefits.
Both entities may also have to file an annual report with the state. Regardless of which entity you choose, we can help you make sure you are meeting your ongoing responsibilities to the state.
Differences
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Business Purpose
Some states limit the use of LLPs to businesses offering professional services, such as lawyers, accountants, or doctors.
LLCs, on the other hand, usually can be formed for any type of business. In fact, many states allow LLCs to be formed for any lawful purpose, that is, a specific business purpose is not required. However, a few states prohibit certain licensed professionals from forming an LLC, and others require professionals to form a special kind of LLC called a professional limited liability company.
Because the law varies by state, it is essential to work with us to ascertain the types of entities your business is permitted to form.
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In most states, LLCs can elect to be member managed, or the members can designate or hire one or more managers, creating a manager-managed LLC. All the members can participate in the management of a member-managed LLC, although they may choose to alter these rights and responsibilities in their operating agreement. Only managers can manage the operations of a manager-managed LLC. If the articles of organization do not specify that the parties have elected a manager-managed structure, state LLC statutes generally default to a member-managed LLC.
In an LLP, all the partners can participate in the management of the business, as is the case in a general partnership. Unlike an LLC, there is no option to hire an outside manager.
We Can Help
The factors discussed above are only a few of the important considerations relevant to choosing the right structure for your business. The decision about which type of business entity to form is a complex one that will depend on your particular circumstances and the goals you seek to achieve. We can provide guidance about the type of business structure that will work best for you. Please call us today at (314) 966-7766 to set up a meeting.