Pros and Cons of LLP vs. Partnership

By River Braun, J.D.

Pros and Cons of LLP vs. Partnership

By River Braun, J.D.

Partnerships and limited liability partnerships (LLPs) are businesses formed by two or more people; both have many similar characteristics. The most obvious difference between these two types of entities is protection from personal liability. Understanding the differences between them can help you make an informed decision on your business entity choice.

Two coworkers looking at paperwork together while other coworkers work behind them

Personal Liability Protection

Personal liability protection is the main difference between these entities. A standard partnership offers no protection from personal liability. Each partner is responsible for all professional debts and obligations. For example, if you are one of four general partners in an architectural firm and a client sues one of them over a bad design, the plaintiff can seek satisfaction for any judgment against that individual through the personal assets of you and the other owners in the event the malfeasant person cannot pay.

In contrast, with an LLP, each owner benefits from insulation from the actions of the other partners. Note that the company does not shield you from liability for your own actions. States vary on such protections, so consult the laws of the state in which you conduct business to understand how your state's laws apply to your situation.

Forming an LLP or Partnership

Of the two types, the easiest (and riskiest) to form is the general partnership (GP). You can create this even without intending to create one. This implicit entity forms when two individuals carry on business in the manner of partners and inadvertently end up creating liability they did not know existed.

This can happen, for example, when two individuals mean to work as independent contractors but do not create a contract that specifies the relationship. GPs can also form expressly, through the creation of a written contract. LLPs, on the other hand, form by filing paperwork with the state in which you plan to operate.

For the most part, two or more individuals who want to operate a business can form this type of entity. In some states, such as California, only professional partnerships, including those created by doctors, accountants, architects, or attorneys, can form as LLPs. If you create a company that does not require professional licensing with another individual in a state that restricts them to professional organizations, consider forming an LLC instead. It provides limited liability and GP taxation.

Partnership Taxation

The Internal Revenue Service (IRS) grants both types of entities pass-through taxation, meaning the profits and losses of the company pass directly to the owners, who must report any earnings or losses on their personal tax returns. Unlike corporations, its does not pay income tax.

Any time you conduct business with another person, draft an agreement that explicitly sets forth the nature of the relationship. Without this, you could inadvertently place yourself at risk for the actions of your partner. If you have questions or need help deciding which type of entity to form and how to begin organizing it, you can speak with a tax professional who can help you determine which one is best for you.

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