Understanding Limited Liability Partnerships
A limited liability partnership (LLP) is a business structure where the owners are protected from unlimited liability. Essentially, each partner cannot be held liable for the acts of the other partners.
In this article, we’ll share what you need to know about LLPs to decide if it’s right for you.
What is a limited liability partnership?
An LLP is a business structure comprising two or more owners with limited liability. Because the business venture is made up of partners, members can mitigate risk, leverage individual skills and expertise, and establish clear divisions of labor. And if the business fails, creditors cannot typically go after each partner’s personal assets or income.
Features of limited liability partnerships
An LLP must be made of at least two members. Each partner shares costs, responsibilities, losses, and profits. The partners can choose their level of involvement and have limited liability. Different states provide different degrees of liability protection. In some states, the only potential loss is the partner’s initial investment. Other states, however, limit liability if the failure or loss is due to negligence.
Limited liability partnerships are pass-through tax entities, so the profits are taxed on each partner’s tax return.
How are LLPs different from other types of partnerships?
LLPs differ from other types of partnerships in key ways. To learn more about other partnerships, read “Different types of partnerships.”
LLPs vs. general partnerships
A general partnership consists of two or more members who typically share liability, profits, and losses equally (unless otherwise stipulated). The primary difference between a general partnership and an LLP is general partners have unlimited liability.
LLPs vs. limited partnerships
In a limited partnership, one member is the general partner and controls all assets and management responsibilities. They also have unlimited liability. The other members are typically silent partners, and their liability is limited to their investment in the business venture. In an LLP, however, all partners have limited liability and can have a say in business operations.
To learn more, read “What is a limited partnership?”
LLPs vs. limited liability companies
Limited liability companies (LLCs) and LLPs both provide personal liability protection. Generally, an LLC offers more protection.
An LLC also provides more flexibility in the business’s tax structure because a single individual can form an LLC, but an LLP must consist of at least two members. This means an LLC can be taxed as a partnership, sole proprietorship, or corporation, but an LLP can be taxed as a partnership or corporation.
Learn more about LLCs in our article “What is an LLC?”
Advantages of limited liability partnerships
There are many advantages to forming an LLP.
- Members of an LLP share costs without being held responsible for the acts of the other partners. Each partner’s liability is limited to what they invested in the business and agreed upon in the partnership agreement.
- The partnership agreement outlines each partner’s level of involvement, which provides flexibility in how the company is managed.
- LLPs face fewer restrictions and compliance issues than many other business structures.
- Because LLPs are pass-through entities, income is reported on each partner’s tax return to avoid double taxation, which corporations have to contend with.
- It’s fairly easy to add new partners (either individuals or companies) who can bring existing business to help the partnership grow.
Disadvantages of limited liability partnerships
As with any business structure, there are also disadvantages to forming an LLP.
- Limited liability partnerships cannot release stocks to the public.
- Partners of an LLP cannot take W-2 wages and must pay self-employment taxes.
- Not all retirement options are available to the owners of an LLP.
- Other business structures, such as LLCs, provide more thorough liability protection to owners.
- Transferring legal rights outside of the primary state of operation can affect each partner’s level of liability.
How are LLPs managed and operated?
There is quite a bit of flexibility in how LLPs are managed and operated because the duties and responsibilities of each owner are included in the partnership agreement. The partners can decide how the business should be run and by whom. They can agree to delegate daily business operations, divide duties equally, or split responsibilities based on expertise and experience.
Partners decide how to divide profits and when to pay themselves. They may choose to split profits equally among all owners or pay members a percentage of profits based on their initial capital contributions.
Additionally, all partners can make business and operation decisions as outlined in the partnership agreement.
How to draft a partnership agreement for an LLP
When you form a limited liability partnership, you must draw up a written partnership agreement. Each partner contributes to this agreement, which outlines all important matters relating to business operations.
You should include the following information in your partnership agreement:
- Each owner’s name, capital contributions, and ownership interest
- The duties, responsibilities, and expectations of each partner, including decision-making and voting rights
- How and when profits are divided and paid to each partner
- Each owner’s liability
- Procedures for appointing new members and removing existing owners
- Dispute resolution processes
Is a limited liability partnership right for your business venture?
An LLP may be right for your business if you’re concerned about personal liability. It may also be preferable over forming a corporation because LLPs are only taxed once, as opposed to the double taxation of corporate earnings.
LLPs are common in professional practices, such as law firms, accounting firms, medical practices, and wealth managers. That’s because these types of firms are often subject to malpractice suits or similar faults of a partner.
Conclusion
Limited liability partnerships can be advantageous because they allow each owner to enjoy limited liability. If you want to dive deeper into this business structure, read “What is an LLP?”