Entrepreneurs, business owners and investors starting new ventures sometimes wonder about the difference between an LLC and LLP choice. But the LLC vs. LLP question doesn’t have to all that confusing or complicated once someone understands how these two entities are created, what legal protections and tax benefits they offer, and when they’re required.
Note: The acronym “LLC” stands for Limited Liability Company and the acronym ”LLP” stands for limited liability partnership.
Creating a limited liability company versus limited liability partnership:
Both LLCs and LLPs are created by filing articles of organization or formation with the appropriate state government agency—typically the Secretary of State for the state. The paperwork varies, but in general the filed articles name the new LLC or LLP, briefly describe its activities, and provide contact information for the state and other interested parties.
In terms of formation, then, forming a limited liability company usually closely resembles forming a limited liability partnership. And often the articles of formation or organization amount to a simple one or two page form where the organizer of the new entity “fills in the blanks.”
LLCs and LLPs have much in common. The way they differ is in terms of liabilities and the agreement made for the business. Find out which one should you opt for.
Limited Liability Company (LLC)
A Limited Liability Company, or LLC, is a business company that can limit liability to the owners, single or otherwise. These liabilities may arise from the activities of the company and are limited to the capital contribution made by the members of the LLC. Members can be individuals or other corporations and partnerships. The interest of the member, which is governed by the capital brought in, also limits or governs the distribution of profits to him/her. The member of an LLC can also manage the business depending on the agreement made with the LLC. An LLC is also able to appoint a manger or supervisory team to run the day-to-day affairs of the LLC. LLCs have to be registered with the statutory authorities through an Article of Association. An LLC may have an operating agreement, which will clearly define its business, the rights of its various members and managers. A sole owner can form the LLC.
Limited Liability Partnership (LLP)
A limited liability partnership is one in which the liability of all or some of its partners is limited. Some countries require that at least one of the members of such a partnership have unlimited liability, though this is not the case in the United States. In an LLP the partners have a right to manage a business directly, unlike in corporations where a board of directors that is elected by the shareholders has to undertake that responsibility. As the word indicates LLPs can be formed by two or more members and indicates a partnership in business interests. The partners have interests in the company with the scope of each limited to the extent or percentage of investment that he has put in to form that LLP.
Commonality between LLC and LLP
In the case of both LLCs and LLPs the tax liability is passed on to the owners or members or partners and they are personally responsible for any tax to be paid as a result of their receiving any moneys from the company in which they have interests. The company or partnership itself will only pay such taxes that are due as a result of their operations either from material purchased or sold. The full liability for income tax is that of the members or partners of the LLC or LLP.
Which Formation is the Best?
Deciding on the best formation for the business you are into will depend on your personal circumstances and the way you are proposing to run the business. If the total capital to start the company belongs to you as an individual and you alone are going to be responsible for its operations and all future decisions, it is better to form an LLC. This will limit your liability to the extent of the capital you have invested. However if you have made any personal guarantees while arranging loans or credit for your business, these guarantees can force you to extend the force of your personal assets to any liabilities that the LLC incurs.
If there is a need for you to include any other partner for the running of your business, either because you need the finances or alternatively need the partner’s intellectual or other resources, a LLP is a better alternative. The extent of the interests of the partners has to be laid down in an Article of Association and filed with the requisite authorities. This will govern the risks and liabilities that each partner will be liable for in case of any losses caused by operations or as a result of any legal action against the LLP.
It is best to take the advice of legal eagles that have made a profession of tendering such advice. Also keep your CPA or financial adviser very much in the picture and then take the decision based on the advice you get; and of course your own judgment.
Legal Protections Offered; LLC vs. LLP:
A limited liability company and a limited liability partnership offer, essentially, the same legal protection. Both entities shield owners from liability related to the operations of the entity. In other words, if an LLC or an LLP engages in some behavior that triggers financial liability, the LLC members and the LLP partners are not liable merely by virtue of their status as owners.
Note: The owners of a limited liability company are called members, and the owners of a limited liability partnership are called partners.
Similarly, if an LLC or LLP breaches a contract and the breach creates economic damages for another party, again the LLC members and LLP partners are not liable merely by virtue of their ownership.
Moving beyond these LLC vs. LLP generalizations, however, you should note that state laws control the particulars of the legal protections offered by limited liability companies and limited liability partnerships. And in some jurisdictions, a limited liability partnership may have or may be required to have one partner whose personal liability is NOT limited.
Difference in Tax Benefits Between LLC and LLP:
Let me also make a quick point about the tax benefits and the difference between an LLC and an LLP. In general, both LLCs and LLPs don’t require the business to pay income taxes on its profits, but rather that they just “pass through,” or “flow through,” or “distribute” the income, deductions and associated tax liability to the owners of the entity. Note: In comparison, a corporation often would pay income taxes on its business earnings. If those earnings are later distributed to an owner, the owner pays tax again. (This is the dreaded “double tax” you hear corporations and their shareholders talk about.)
When an LLC or LLP is required:
One other point should be made about the LLC versus LLP debate: Some types of businesses in some states may not be able to use an LLC (this is probably most common) or an LLP. For example, one of the reasons that the large law firms and large accounting firms are LLPs is that they can be an LLP in every state. But they can’t operate as an LLC in every state.
Note: In most states, just to be picky, professional service firms don’t actually operate as limited liability companies but rather as professional limited liability companies. But again, when that option isn’t available, a professional service firm that wants to limit its legal liability might need to use either a traditional corporation (if that’s allowed) or a limited liability partnership (if that’s allowed.)
Advantages and Disadvantages of a Kentucky LLC
Advantages
• Limited Liability: Owners of a LLC have the limited liability protection of a corporation.
• Flexible Profit Distribution: Limited liability companies can select varying forms of distribution of profits. Unlike a common partnership where the split is 50-50, LLC have much more flexibility.
• No Minutes: Corporations are required to keep formal minutes, have meetings, and record resolutions. The LLC business structure requires no corporate minutes or resolutions and is easier to operate.
• Flow Through Taxation: All your business losses, profits, and expenses flow through the company to the individual members. You avoid the double taxation of paying corporate tax and individual tax. Usually, this will be a tax advantage, but circumstances can favor a corporate tax structure.
Disadvantages
• Limited Life: Corporations can live forever, whereas a LLC is dissolved when a member dies or undergoes bankruptcy.
• Going Public: Business owners with plans to take their company public, or issuing employee shares in the future, may be best served by choosing a corporate business structure.
• Added Complexity: Running a sole-proprietorship or partnership will have less paperwork and complexity. A LLC may federally be classified as a sole-proprietorship, partnership, or corporation for tax purposes. Classification can be selected or a default may apply.
By Kentucky and other state law in order to proceed with forming a LLC, you need to prepare a written abstract detailing your LLC purpose, the names of your initial Kentucky LLC members, the name and address of your Kentucky registered agent, the details of which will be introduced into the body of your LLC operating agreement and related Kentucky LLC formation documents assembled for application to the state of Kentucky.
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