An important aspect of starting a business is choosing which type of business entity to create. Two popular business entities are limited liability companies, or LLCs, and limited liability partnerships, or LLPs. Each entity has unique characteristics, but both are also similar in many ways, including the way they are taxed by the IRS.
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The IRS defines an LLC as “an entity formed under state law by filing articles of organization.” An LLC limits its owners’ -- called "members" -- liability while also providing flexibility in management and taxation. On the other hand, the IRS defines an LLP as a business entity “formed under a state limited liability partnership law.” Partners in an LLP are not typically liable for the debts or negligent acts of another partner.
Members in an LLC have two options for setting the company’s management structure: they can manage the company themselves, or hire or appoint outside managers with no ownership stake in the company. In an LLP, the partners manage the affairs of the partnership. If LLC members elect to manage the company, they typically then manage the company the same way LLP partners manage the company, with partners having voting rights based on their contribution to the company.
LLCs can either be taxed like a partnership or like a corporation. Because the IRS has no specific tax classification for LLCs, multi-member LLCs are automatically taxed as partnerships. LLPs are taxed as partnerships where the profits and losses from the business must be reported on the partners’ personal income taxes. LLCs can have only one member, whereas an LLP must have at least two partners. A single-member LLC may be taxed as a sole proprietorship or a corporation.
LLCs and LLPs have some similarities in that they limit the liability of members and partners, respectively. Members of an LLC cannot usually be held liable for the debts or liability of the LLC. This protection is typically referred to as the “corporate veil” or “corporate shield.” However, in some cases -- usually involving fraud or deception -- LLC members can be personally liable for the acts of the LLC. In contrast, LLPs limit the liability from one partner to another. In other words, each partner is not liable for the debts or negligent acts -- should a partner be sued -- of the other partner. This liability protection is often suited for lawyers, doctors and accountants where one partner wants protection from any potential malpractice another partner may commit. LLP partners, however, are generally liable for the contracts and debts that the LLP itself enters into.