What Is an LLP? Limited Liability Partnerships Explained
Is an LLP the right entity type for your business?
- May 4, 2020
- Starting Your Business
- 8 min read
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You might not be aware but businesses that are organized as a limited liability partnership, or LLP, are quite common. Just think about companies you’ve seen or heard of whose name is a series of last names, such as “Smith, Jones and James,” which are often associated with lawyers or accountants. When you see company names in this format, you’re very likely looking at an example of an LLP.
But why would a business choose to form as an LLP? Indeed, a more pertinent question is, which businesses can organize themselves as an LLP? Just as there are restrictions for business entities such as a limited liability company (LLC), C corporation, S corporation or sole proprietorship, there are critical regulations for becoming an LLP. Read on to find out what an LLP is, what kinds of businesses can be LLPs and the advantages and drawbacks of this type of organization.
In order to understand what a limited liability partnership is, it is important to know what a general partnership is. A general partnership is a for-profit business entity that is created by a mutual understanding between two or more parties. In other words, two or more people want to work together to make money. This can make general partnerships fairly informal, requiring little more than a shared interest, a handshake and maybe a written contract, although this is not a legal necessity.
The informal nature of a general partnership can be convenient, but it also comes with its own drawbacks. The clearest risk is that of legal liability, because, in a general partnership, all partners share liability for any problems that can emerge. This is where a limited liability partnership (LLP) comes in, providing what would otherwise be a general partnership with some limited personal liability for its partners. Since an LLP is a partnership, it must have two or more owners.
The level of liability limitation for an LLP can change depending on the state the business is located in. Usually, however, an LLP possesses some kind of limited potential personal liability for the debts, negligence or wrongdoing of other partners in the company’s organization. That said, LLP partners are still responsible for their own individual mistakes or intentional transgressions. For more information about individual state laws and regulations regarding LLPs, a good place to start is with the Secretary of State’s office in your respective state.
A major point about LLPs is that the types of businesses that can organize themselves in this way are restricted. A restaurant or car dealership, for example, cannot be organized as an LLP. Instead, an LLP can only be created by certain types of professional service businesses. These types of businesses include accountants, attorneys, doctors, dentists, architects and other fields that are treated as professionals under different states’ laws. So when you see a business name that consists of multiple last names, you can deduce that those are the last names of the LLP’s senior partners.
What’s great about LLPs is their flexibility. In a limited partnership (LP), limited partners cannot take on management responsibility, while in a general partnership, partners are personally liable for other partners’ actions and financials like the business’s debt. With an LLP, however, partners can assume management responsibility while enjoying a degree of limited liability that general partnerships don’t receive. As with any legal business entity, it’s essential that you check federal laws but especially state laws because they are the main regulator of business organizations.
Remember that the rules for businesses that can form an LLC are governed on the state level, so there will be variations based on where you work and live.
Here are the steps to form an LLP:
- Verify that your business qualifies to organize as an LLP. The best place to go for this is your state secretary’s office, where you’ll find out who qualifies.
- Choose a name for your business that fits with state regulations, such as the inclusion of “Limited Liability Partnership”, “LLP” or other necessary terms
- Draw up a limited liability partnership agreement. This is not mandatory in every state, but it is a smart move for ensuring organization and smooth operations.
- Designate a registered agent to represent your company and manage service of process, such as receiving paperwork in regards to lawsuits against your business.
- File a Certificate of Limited Liability Partnership to the appropriate state authorities. Whereas your limited liability partnership agreement is not legally required, filing for a certificate is mandatory.
- Get an Employer Identification Number (EIN) for your business. If you want to open business bank accounts, hire employees and make certain business transactions, you’ll need to register for an EIN for your LLP.
- Obtain the business licenses and permits necessary for your business to operate. Since LLPs are companies involved in the professional service business, such as doctors, lawyers and accountants, permits and licenses are even more critical here than for more other small businesses.
- Get the business insurance required for operating your LLP in the state. Often, states require LLPs to buy specific insurance plans, beyond the usual necessary ones like workers’ compensation insurance. An obvious example of this is requiring malpractice liability insurance for medical LLPs.
Depending on your state, there could be additional steps needed to set up an LLP. For instance, some states require businesses to publicize their LLP formation. This publication can be in the form of newspapers in the county in which the LLP is located. The publication notice typically must include your business’s name, date of formation, physical address, registered agent and description of the business.
Forming a business as an LLP carries a lot of advantages. Of course, the biggest point to understand is that not every company can simply organize themselves as an LLP, so these advantages are not open to everyone. Your company essentially needs to be in the professional services business. Here are some of the benefits of forming your business as an LLP.
The flexibility of an LLP for certain types of professional businesses is what makes it a better option than an LLC, general partnership, limited partnership or other corporate entity. Partners in an LLP have to flexibility to conduct their professional services while at the same time assume important management responsibilities. This is in contrast to limited partners in a limited partnership who must take a back seat to day-to-day management. What’s more, an LLP has the ability to bring in partners and let partners out. Since a partnership agreement exists for an LLP, partners can be added or retired as outlined by the agreement, which is very useful because you can always add partners and bring their existing business with them.
Related: How to Get a Business License
Similar to an LLC, an LLP is a flow-through entity for tax purposes, which means that the company’s partners receive untaxed profits and pay the taxes themselves on their personal tax return. In regards to taxation, both an LLC and LLP can be advantageous because owners are only taxed once, unlike a C corporation, which is taxed twice: First, as a business entity in the form of corporate income taxes and, second, when its shareholders are taxed on distributions.
Read This: Small Business Tax Guide
In most cases, LLPs are created and managed by a group of professionals — such as doctors, lawyers or accountants — who have considerable experience and bring in many clients. When these professionals combine their resources and clientele, they reduce the costs of doing business while increasing the LLP’s capacity for growth. Lowering operating costs enables the partners to attain higher profits from their activities than they could individually.
Related to both scalability and flexibility is the fact that partners in an LLP can also have a number of junior partners. These individuals work for the LLP with the general expectation of someday becoming full partners. Junior partners and employees can focus on detail work while freeing up the senior partners to focus on bringing in new clients and expanding the business.
There aren’t many hard drawbacks to forming an LLP. This is due in part to the fact that businesses that organize themselves as LLPs do so out of necessity. Doctors or lawyers, for example, cannot organize their businesses into whatever form they wish and, therefore, choose an LLP as their business entity. Here are some disadvantages that you may encounter when forming an LLP.
If you want to expand your LLP to another state, you could run into some issues. Some states recognize LLPs that were formed in other states, which are referred to as foreign LLPs, but other states do not. Since the rules regulating LLPs are state-based, your company might be eligible to operate as an LLP in one state but are disqualified from this type of organization in others. The main reason why this is a problem, besides limiting business expansion, is that it could impact the limitation of liability for your company in the other states. For example, a state may treat a foreign LLP as a general partnership for purposes of personal liability, which undermines one of the fundamental advantages of forming an LLP.
An additional drawback of LLPs is that individual partners are not always required to consult with other participants in certain business agreements. Thus, one partner’s actions could expose all partners to risks without their knowing it. The best way to protect against such scenarios is by creating a partnership agreement that outlines in detail what each partner can and cannot do when making business decisions.
Some other disadvantages of LLPs are concerned with financials. Some states have special tax considerations for LLPs, which can make tax filing a very complex procedure. In fact, some states don’t allow LLPs at all because of the tax complexities associated with them. Another potential financial issue with LLPs is that their financial statements have to be disclosed publicly.
The main point to take away is that an LLP is a business organization that combines elements of a general partnership with the limited liability protection found in other entities such as LLCs. However, the degree of limited liability is not as protective as for members of an LLC or corporation. Forming a company as an LLP is typically restricted to certain business types, namely professional services businesses: Doctors, dentists, lawyers, engineers, architects, accountants and similar professions. What’s more, depending on which state your business is located in, the recognition and regulation of LLPs can vary substantially. As with choosing any business entity, you should do your homework researching which state authorities handle registration and rules for this type of business organization.
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