Understanding both the limitations and benefits of an LLC versus an LP is important for new business owners who are deciding which type of entity would be best suited for their company. Limited partnerships (LPs) and Limited liability companies (LLCs) are two of the most common business entities. If you are forming a business with at least one other person, you have the option to choose between these two business formation options.
Here are some factors to consider when deciding whether to form an LLC or an LP with your business.
An LLC might be best for your new business if one or more of the following apply:
While an LP might be better if one or more of the following apply:
The IRS treats LLCs and LPs the same for tax purposes upon formation. An LLC, however, has the option of electing to be taxed as though it were a corporation. Limited partnership tax treatment on the other hand doesn't allow for such an election.
If you prefer partnership taxation, there is no tax advantage to choose one of these entity types over the other. However, if you want your company taxed as a corporation, you must organize it as an LLC and file the necessary form with the IRS to elect corporate taxation treatment.
Depending on where you live, you may also need to think about state taxes. Some states tax LLCs as corporations and which means they cannot be taxed as a partnership. This can lead to double taxation, wherein the corporation is taxed on profits, and the members are also taxed on their share of the profits.
There are a few main differences in the way LLCs and LPs are structured and created. Business owners should also be aware that a member of an LLC, as well as a partner in an LP, may be an individual person, a corporation, another LLC, or another partnership.
Here are some key organization differences:
A person who has ownership interest in an LLC is known as a member. While an LLC with two or more members is called a multiple-member LLC. Forming an LLC requires filing a document, known as an Articles of Organization with your state agency that regulates business entities. Many LLCs are also required to have an Operating Agreement, which explains in detail the members' ownership interests, rights, and responsibilities.
An individual that has an ownership interest in an LP is called a partner. An LP has two types of partners: they are known as general partners and limited partners. There can be one or more general partners or limited partners.
While both partners own a certain percentage of the company, only general partners can engage in operating the business. Limited partners are passive investors that share in the profits and losses but do not have a say in how the business is ran. Having passive investors is the biggest advantage of forming a limited partnership.
An LP is typically formed by creating a Partnership Agreement, which details the ownership interests, rights, and responsibilities of both the general and limited partners. As with an LLC, you must also check with your state for any necessary state registrations that are needed.
Since business entities are created under state law, it is advisable to see if there are any significant differences between registering an LLC and an LP in your state. For example, some states prohibit certain types of businesses from organizing as an LLC. This may include businesses such as accountants, architects, physicians, banks, and insurance companies.
All of the partners in a business organized as a general partnership can be held personally liable for the business's debts. This means that a partner may be risking more than what they are contributing to the business. This means if the company's debts are greater than the value of their assets, a creditor can go after their personal property. This includes their personal bank accounts, other investments, cars, and real estate.
One of the central purposes of both an LLC and an LP is to limit the owners' personal liability, however, keep in mind that they do not provide the same degree of protection. With an LLC, all of the members have limited personal liability. The members may participate in the management of the business and maintain a limitation of liability.
In an LP, however, only limited partners have the benefit of limited personal liability. This only applies if the limited partner has no active role in managing the company. A general partner is the person who will remain personally liable for partnership debts. Some LPs handle this issue by forming a separate LLC to be the general partner. While this may work for many companies, it requires setting up two entities, the LLC and the LP, and will incur the expense of forming and operating both entities.
**Disclaimer: The content used in the article is not to be used as legal advice and is for illustration and general informational purposes only. If you have questions about your particular situation, please contact us to schedule a consultation with one of our experienced attorneys.