What Is the Difference Between a LLP & an LP?
Choosing the right business entity is an important phase in business formation. Each type of business entity has certain advantages and disadvantages for the partners, including personal liability protection. The type of business, the partners’ goals, and state laws factor into your decision whether to form an LLP or an LP. An experienced Maryland business formation attorney can help you determine whether a limited partnership (LP) or a limited liability partnership (LLP) is best for your needs and goals by comparing the difference between LP and LLP.
What Is the Difference Between LP and LLP in Protecting Personal Assets and Personal Liability?
Deciding between business structures can be confusing. Two or more partners can decide to form a general partnership, limited partnership, or limited liability partnership by entering a written partnership agreement. Each of the business entities offers pros and cons for protecting a financial investment, earning profits, and providing personal liability protection.
Let’s dive into the specifics of an LP and LLP to highlight the pros and cons of each partnership agreement for limited partners and general partners.
What is a Limited Liability Partnership?
A limited liability partnership (LLP) is formed by two or more individuals who desire to conduct business for profit. This business structure can be used by law firms and accounting firms. Licensed professionals often use an LLP to conduct business together. It protects personal assets by limiting the personal liability of limited partners.
An LLP partner is liable for any wrongful acts he commits or is committed by someone he supervises. However, the partner’s personal liability is limited to his capital contribution to the LLP. Therefore, a partner’s personal assets are not at risk for wrongdoing committed by other partners or because of the partnership’s losses or business debts.
Another benefit of forming a limited liability partnership is that you are not required to maintain corporate formalities, such as annual meetings or corporate filings. However, the limited partners are required to meet the requirements the partners set forth in the limited liability partnership agreement. All partners can conduct business for the LLP and participate in management duties. The partnership agreement for a limited liability partnership defines the rights and responsibilities of each of the limited partners.
LLPs provide some tax benefits for limited partners. A limited liability partnership is a pass-through entity for income tax purposes. Therefore, the LLP does not pay taxes for the business entity. All profits of the LLP are “passed” to the limited partners and taxed as personal income for the partners. This prevents double taxation of income earned by the LLP. However, LLPs file informational federal tax returns and K-1 forms to report each partner’s share in the LLP’s profits.
A disadvantage of pass-through taxation is the partners pay self-employment taxes. However, there are some tax benefits of self-employment tax. A limited partner can use tax credits and deductions to reduce their personal tax liability.
A disadvantage of an LLP is that some states limit the types of professions that can form an LLP. For example, some states may limit LLPs to accountants or lawyers. Each partner in an LLP must have a state-issued professional license to conduct business within the state.
What is a Limited Partnership?
A limited partnership (LP) is also a business entity formed by two or more individuals to conduct business for profit. However, the LP must have one or more limited partners. At least one partner must serve as the general partner. The general partner may be a corporation instead of an individual.
As with an LLP, the benefits of an LP include no mandatory corporate formalities, the personal liability of limited partners is limited to capital contributions, and no double taxation since LP’s are also pass-through entities. The business partners pay self-employment tax when they file their income taxes on the income passed through the LP.
However, limited partnerships have several disadvantages that you do not have in limited liability partnerships.
General partners do not have limited personal liability in an LP. Therefore, the liability of the LP extends to the personal assets of the general partners. General partners are personally liable for the business debts of the limited partnership. In addition, a general partner is liable for his wrongdoing, but also the wrongdoing of any of the limited partners in the LP. A general partner can be held personally responsible for actions they were unaware of or did not authorize.
A benefit of choosing this business structure is that a corporation can serve as a general partner. Therefore, none of the limited partners needs to serve as the general partner with unlimited personal liability.
Unlike limited liability partnerships, the limited partners in an LP do not participate in the management of the LP. They are silent partners. Only general partners have the right to manage the LP. The partnership agreement defines the rights and responsibilities of general partners and limited partners.
How Do I Form a Limited Liability Partnership or Limited Partnership?
Forming an LP or LLP begins with a partnership agreement. Maryland does not require a written agreement for a limited partnership, but it does require a formal partnership agreement for an LLP.
Regardless of the state requirements, it is essential that professional partners have a detailed, written partnership agreement. A partnership agreement outlines each partner’s obligations and rights for managing the partnership. Other matters outlined in a partnership agreement include, but are not limited to:
The capital investment of each partner and each partner’s ownership interest
The division of partnership profits and losses
The authority of each partner to bind the partnership to an agreement or contract
How partnership can withdraw funds from the partnership
The process for resolving disputes
How new partners are admitted into the LLP or LP
The rules and procedure for removing a partner
What happens if a partner files for bankruptcy, dies, retires, or becomes disabled
The process for selling or transferring a partnership interest
The procedure for dissolving the partnership
Once you have a signed partnership agreement, the partners must file a Certificate of Limited Liability Partnership or Certificate of Limited Partnership with the Maryland State Department of Assessment and Taxation. The partnership must have a unique name. You must include the initials LP or LLP in the name or the words "limited liability partnership" or "limited partnership."
LLPs and LPs must have a registered agent or resident agent designated to receive legal papers for the partnership. The authorized agent must live in Maryland and be available during regular business hours. A partner may serve as the registered agent, or the partnership may hire a registered agent service for the receiving process.
Forming an LP or LLP with the state is not complicated. You complete and file the paperwork with the appropriate filing fee. However, negotiating a partnership agreement and completing the other steps required to form a partnership can be challenging.
Investing in a partnership is a serious decision. While LLPs and LPs provide limited liability protection, you could be personally liable for specific debts and obligations. A Maryland business lawyer can help you weigh your options to determine if an LLP or LP is the best business structure for your company. An attorney also helps you ensure that you comply with all state and federal laws regarding business formation and taxation.
Would a Limited Liability Company Be a Better Business Structure for Limited Partners?
Maryland does not recognize a professional limited liability company (PLLC). However, licensed professionals can form a limited liability company (LLC). As with limited partnerships and limited liability partnerships, all partners must have professional licenses to form a professional LLC. Licensed professionals must check with the state licensing board to determine whether they need approval to form a professional corporation.
The state does not require a professional LLC to have an operating agreement. However, LLC owners should have an operating agreement to define the rules for the limited liability company. The operating agreement outlines the rights and responsibilities of the LLC owners and how management decisions will be made. It defines how the company will be operated and controlled.
Limited liability companies are pass-through entities like partnerships. LLC owners pay income taxes and self-employment taxes on their share of the company's profits.
A professional LLC helps protect personal assets of the owners but does not protect them from all liability. The LLC offers limited liability protection. Owners may be protected from malpractice by the other members of the LLC, debts owed solely by the LLC, and liability for injuries or harm unrelated to a member's torts or malpractice.
Unlike an LLP or LP, members of an LLC may need to maintain the formal structure of a corporation to benefit from limited liability protection and maintain limited liability status. If so, they may avoid unlimited liability for the professional LLC.
Contact a Business Formation Attorney for More Information
The above discussion of LPs and LLPs is not an exhaustive list of the benefits and issues that you should consider when forming a business entity. An experienced business attorney understands all issues that must be considered when forming a business and selecting a legal entity for the business. Business formation attorney Steve Thienel provides personalized service and legal advice for individuals in DC, Maryland, and Virginia regarding all aspects of business formation and business operations. Call today to schedule a consultation.
