LLC versus LLP Explained



Posted: Thursday, August 27, 2009

by Stephen Nelson
Stephen L. Nelson, CPA

People thinking about starting a new business or making a new investment regularly ask about the difference between an llc and llp. But fortunately, the llc versus llp question doesn't have to be that difficult to answer.

Usually, the right answer is "Go with the LLC." But let me explain...

Both LLCs and LLPs are easy to form

Let me start by pointing out that both LLCs and LLPs are easy to form. In either case, you create the new entity by filing articles with the home state's Secretary of State office. The process varies from state to state, but the paperwork all works the same basic way. The documentation names the new entity, provides an overview of the business's activities, and supplies information about the people setting up the new venture.

Note: You can usually download fill-in-the-blank forms from the Secretary of State's web site for setting up a limited liability company or limited liability partnership. Typically, the forms are a page or two in length-and come with easy-to-understand instructions.

But summing up, then, both an LLC and an LLP get formed in the same rough way and with the same roughly equivalent level of effort and cost. Therefore, the LLC versus LLP question isn't decided by how difficult the company is to form...

LLC versus LLP: Legal Protections Roughly the Same

Here's the next thing to note if you're trying to figure out the difference between an llc and llp so you can make the right choice: LLCs and LLPs offer the same security. LLCs and LLPs both offer business owners legal protection from the risks associated with the business.

When an LLC or an LLP engages in some risky or bad behavior that results in economic liability, for example, the owners of the LLC (called members) and the owners of the LLP (called partners) don't bear legal liability as a result of their ownership status. In a sense, the owners of a LLC or LLP get the same protection that shareholders of a corporation do. (If you own shares of some big industrial company or oil company, you aren't liable for their actions simply because of those shares...)

But a couple of qualifications are necessary here: The legal protection offered by a limited liability company or partnership may be limited by state law. And, very importantly, members and partners may regularly bear liability not because of their ownership but because of their actions on behalf of the limited liability company or limited liability partnership.

Summing up, because the legal liability protection offered by an LLC resembles that offered by an LLP, one also needs to look beyond issues of liability in order to answer the LLC vs LLP question...

Taxation Differences between an LLC and LLP?

As a generalization-and I won't spend any great time on this-LLCs and LLPs receive the same income tax accounting treatment. By default, both LLCs and LLPs would usually be treated (by default) as partnerships. Both LLCs and LLPs usually also have the option to elect to be treated as regular "C" corporations and also (assuming they meet the other criteria) as "S" corporations.

In many cases, partnership tax accounting treatment saves taxes and makes it easy to form and dissolve a business entity. So the partnership tax accounting angle is a huge benefit-but it's a benefit available both to LLCs and LLPs... and therefore doesn't explain the difference between an llc and llp.

LLC versus LLP: Are Both Options Practical or Available?

Here's a final point-and the one that probably explains why and when a business decides to use the LLP option rather than the LLC option.

Some multi-state businesses (like large public accounting firms and large law firms) may not be able to use the limited liability company option is all the states where they operate. When this is the case, the large firm (again, often a professional service firm) probably can operate as a limited liability partnership in all the states where they operate. And this "pretty much works everywhere" aspect explains why and when a business becomes an LLP, or limited liability partnership.

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CPA Stephen L. Nelson serves entrepreneurs and investors in the Seattle area. He also publishes a limited liability company FAQ column, where his most recent article discussed the difference between an llc and llp.
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