What Is a Limited Liability Partnership?

Coryanne Hicks
·6 min read

LLP stands for limited liability partnership. As the name suggests, an LLP provides its members with a degree of liability protection, shielding them and their personal assets.

An LLP is an entity created by state law, usually used for professional practices, such as legal, accounting or architecture firms, says Michael J. Greenwald, partner and Business Entity Tax Practice leader at Friedman LLP, a New York-based business consulting firm. Different states provide different degrees of liability protection to members.

"A partner of a registered limited liability partnership is generally not liable, even by way of indemnification, for any debts, obligations or liabilities of the partnership itself or of its other partners," says Alan Goldenberg, tax principal at Anchin, a New York accounting firm. "Accordingly, individual partners are themselves not liable for other partners' misconduct or debt and also are not individually liable for the partnership's obligations or liabilities."

Kristin Roberts, assistant program chair of accounting for Post University, identifies two types of LLPs: operating LLPs, where there is a business or service being provided by the LLP, and family or investment LLPs, where there is no product or service. In the latter case, "the LLP is used as an investment tool," she says. "The partners contribute cash and/or marketable securities to the LLP, and in turn the LLP invests those assets further, which could be in marketable securities and/or publicly traded partnerships," or PTPs.

In either case, the LLP must be defined by an operating agreement, she says.

[READ: How to Capitalize on After-Hours Trading.]

Difference Between an LLP and LLC

An LLC is a limited liability corporation. Like an LLP, it is a business entity created by filing an operating agreement with your state. The difference between an LLP and LLC comes down to the degree of liability protection provided, how the entity is taxed and its managerial structure.

Both an LLP and LLC provide personal liability protection, but generally, an LLC provides more. Members of an LLC can only be held personally responsible in cases of business mismanagement. Partners of an LLP, on the other hand, are more subject to the whims of their state. In some states, partners are only protected from another's negligent acts while still being responsible for the business's debts and obligations. Some jurisdictions also require a managing partner of the LLP who retains unlimited personal liability.

An LLC also has more flexibility in its tax structure. An LLP must file as a partnership for tax purposes, while an LLC can choose to be taxed as a partnership, sole proprietorship or corporation. This allows an individual to form an LLC, while an LLP must have at least two partners.

Both an LLP and LLC give members flexibility over business management. All members can be given a say in how the business is run, or some members can be passive investors who do not contribute to the management of the business.

While LLPs and LLCs have similar advantages, Roberts says, "Many business professionals choose the LLC route, unless their profession prohibits it."

[Sign up for stock news with our Invested newsletter.]

Benefits of Forming an LLP

The primary benefit of an LLP is its limited liability protection. "The liability is limited only to what the partner has invested in the LLP," Roberts says. "This provides a level of protection for the partner against possible creditors of the LLP," and is generally a significant benefit for LLPs operating as a business.

With investment LLPs, the benefit is the ability for partners to "pool their resources and perhaps invest in securities and/or PTPs that they may not have been able to invest in on their own," she says. "Since, by nature, there is more than one partner in an LLP, the risks associated with investments are shared by all partners, as are the returns on those investments."

Partners can also share the operating costs of the LLP, such as investment, legal and accounting fees, she says.

Meanwhile, LLPs function as pass-through entities, "meaning the income, deductions and credits earned by the LLP will pass through to the partners, who are liable for the requisite income tax liability," Goldenberg says. "This helps avoid a double layer of taxation, at the entity level and again at the individual level, which corporations need to contend with." Partners of an LLP file their share of the profits or losses on individual tax returns.

Another benefit to an LLP is the flexibility and control it provides over how the LLP is managed. "The operation of the LLP and distribution of profits is determined by written agreement between the partners," Goldenberg says. "This may allow for greater leeway in the management of the business."

Partners can decide how the business should be run and by whom. "LLP partners can agree to delegate daily business operations to a managing partner or to a committee of partners, or the partners can divide duties based upon expertise or experience," he says.

[Read: How to Buy IPO Stock at Its Offer Price.]

Drawbacks of an LLP

"Management of the LLP can become a downfall if not handled properly from the start," Roberts says. "Just because someone may own more of the LLP than another partner, this may not flow through to decision-making or daily management."

She recommends consulting an attorney to ensure the proper articles of organization and/or management are appropriately adopted.

LLP partners may also benefit from hiring a tax accountant for help with filing tax returns. "The tax return for investment LLPs can be very complicated and costly," Roberts says. "It's not as simple as 'number dumping,' which is simply taking the numbers reported on year-end tax statements and putting them directly into tax software to produce a tax return."

For LLPs that invest in PTPs and other securities, you must translate the K-1 information from the PTP and investment activity into a tax return reporting on an accrual basis, she says.

Other drawbacks to an LLP include the fact that since partners are not employees, they can't take W-2 wages and must pay self-employment taxes, Roberts says. Some retirement vehicles are also unavailable to LLPs.

"Oftentimes, if a business is considering an LLP, we may suggest looking at the establishment of an S corporation," she says. "An S corporation can provide other tax benefits that an LLP does not," such as the ability of members to be on payroll. "This makes the profits running through to the member's personal return subject only to income tax and not the 15.3% self-employment tax." S corporations also provide additional retirement options that LLPs do not.

The decision ultimately comes down to first, what your state allows, and then what features are most important to you.