Limited Liability Company vs. Limited Liability Partnership: Key Distinctions for Your Business

Ownership and management differences

The most fundamental difference between LLCs and LLPs lies in their ownership requirements and management structures. LLCs can operate with a single owner (member) or multiple owners. LLC members can choose between active management roles or passive investment positions, and ownership percentages can be structured independently of capital contributions. These should be outlined in an operating agreement.

LLPs, by contrast, require at least two partners and typically operate with more egalitarian management structures. Partners generally share management responsibilities and decision-making authority, though written partnership agreements can establish different roles. 

Liability protection variations

While both structures offer limited liability protection, the scope and nature of this protection differ significantly. LLC members enjoy limited personal liability for business debts, claims, and obligations. Creditors generally cannot pursue members' personal assets to satisfy business debts, though members remain liable for their own negligent or intentional acts.

LLP partners receive more targeted liability protection, specifically shielding them from personal liability for other partners' professional errors, negligence, or misconduct. 

Formation and compliance requirements

Limited liability company formation typically involves filing articles of organization with the state, paying filing fees, and creating an operating agreement (though not always legally required). The process is generally straightforward and can often be completed online. Ongoing compliance requirements usually include annual reports and franchise taxes, but specific requirements vary by state.

LLP formation requires filing a partnership registration or similar document with the state, along with filing fees. Many states require LLPs to file annual reports and pay franchise tax. The compliance burden can be more complex for LLPs, particularly businesses operating in multiple states or serving licensed industries with additional regulatory requirements.

Advantages and disadvantages of LLCs and LLPs

Choosing between an LLC and LLP requires careful consideration of each business structure's benefits and drawbacks in relation to your specific business needs, industry requirements, and long-term goals. 

Pros and cons of forming an LLC

Pros of LLCs:

• Flexible ownership structure allows single or multiple owners with customizable profit-sharing arrangements.
• Strong liability protection shields members' personal assets from most business debts and claims.
• Tax flexibility enables choosing between pass-through taxation or corporate tax treatment.
• Minimal formalities require fewer ongoing compliance requirements compared to corporations.
• Broad industry eligibility accommodates many business types and industries.
• Operational simplicity allows informal management structures and decision-making processes.

Cons of LLCs:

• Self-employment taxes apply to active members' share of profits in most cases.
• Some states have limited professional options because they restrict licensed professionals from forming LLCs.
• Potential franchise taxes in some states can increase operational costs. 
• Membership transfer restrictions may complicate bringing in new owners or investors.
• Varying state laws may create complexity for multistate operations.

Pros and cons of forming an LLP

Pros of LLPs:

• Professional liability protection means that partners are not held personally responsible for other partners' malpractice or negligence.
• Familiar partnership structure maintains traditional partnership management duties and profit sharing.
• Pass-through taxation avoids double taxation while allowing flexible profit distribution.
• Professional credibility enhances reputation among clients in licensed industries.
• Shared expertise enables partners to leverage one another's skills and client relationships.

Cons of LLPs:

• Professional restrictions often limit eligibility to specific licensed professions.
• State requirements mandate that some LLPs carry liability insurance coverage or bonds in many states.
• Multistate complexity complicates operations across state lines due to varying recognition rules.

Who should consider an LLC vs. an LLP?

The choice between an LLC and LLP often depends on your industry, business goals, ownership structure, and state regulations. Understanding which scenarios favor each legal entity type will help you make an informed decision that supports your business objectives while providing appropriate liability protection and tax benefits.

Ideal candidates for LLC formation

• Solo entrepreneurs and consultants: Freelancers, independent contractors, and service providers can have limited personal liability (asset protection) while maintaining operational simplicity and tax advantages in a single-member LLC.
• Small businesses with multiple owners: Retail businesses, restaurants, real estate ventures, and certain business partners often choose LLCs for their operational flexibility and growth potential.
• Businesses planning multistate expansion: LLCs often have broader state recognition and more uniform regulations across jurisdictions. Companies expecting to attract investors or sell ownership interests often find LLCs more accommodating than LLPs for these transactions.

Ideal candidates for LLP formation

• Licensed professional groups: Law firms, accounting practices, architectural firms, and medical practices benefit from liability protection against partners' malpractice while maintaining the collaborative structure essential to professional service delivery.
• Established partnerships: Existing general partnerships can typically convert to a limited liability partnership for added liability protection while preserving their management structure and client relationships.

How to form an LLC or an LLP

The formation process for both an LLC and an LLP is generally straightforward, but there may be some slight differences depending on the state in which you’re registering. Here are the general steps, with key distinctions to remember for LLC vs. LLP. 

Step 1: Choose your legal entity name

Select a unique business name that complies with your state's naming requirements and reflects your brand identity. In most states, an LLC or LLP business name must include the identifiers "Limited Liability Company," "LLC," “Limited Liability Partnership,” “LLP,” or an approved abbreviation, and it cannot conflict with existing business names in your state. Search your state's business registry to verify name availability, and consider reserving your chosen name if you're not ready to register your business name immediately.

Step 2: Designate a registered agent

Appoint a registered agent with a physical address in your state of formation to receive legal documents and official correspondence on behalf of your business. You can serve as your own registered agent, designate another individual, or hire a professional registered agent service. LegalZoom’s registered agent service offers privacy protection and ensures that important documents are shared promptly.

Step 3: File formation paperwork

Submit your formation documents to your state’s filing office, typically the Secretary of State. Fill out the required form for your chosen legal entity. An LLC may also be required to submit its articles of organization (also called a certificate of formation in some states).

Step 4: Create an operating or partnership agreement

Draft a comprehensive operating agreement or partnership agreement that outlines your business’s management structure, member/partner rights and responsibilities, profit distribution methods, and procedures for major business decisions. While not legally required in all states, drafting these agreements is a business best practice. 

Step 5: Obtain an EIN and open business accounts

Apply for an Employer Identification Number (EIN) from the Internal Revenue Service or use LegalZoom’s easy EIN service, which serves as your business’s tax identification number. Use your EIN to open dedicated business bank accounts, which help maintain the separation between business and personal finances essential for liability protection.

Step 6: Comply with licensing and permit requirements

Research and obtain any business licenses, permits, or professional certifications required for your industry and location. Requirements vary significantly based on your business type, location, and activities. Contact your local business licensing office and industry regulatory bodies to ensure full compliance.

Step 7: Understand ongoing compliance obligations

Familiarize yourself with your state's ongoing compliance requirements, which may include annual reports, franchise taxes, and registered agent maintenance. Some states require both LLCs and LLPs to publish formation notices in local newspapers or maintain specific records. Staying current with these obligations helps preserve your business’s good standing and liability protection.

How LegalZoom can help you start your LLC or LLP

Selecting between a limited liability company and a limited liability partnership represents a critical decision that will influence your business operations, personal liability exposure, and long-term growth potential. Consider your current needs while also thinking about future plans for expansion, additional partners, or changes in business focus.

If you’ve decided to form an LLC rather than an LLP, LegalZoom’s business formation services can help streamline the formation process and ensure compliance with all state requirements. Our experienced team understands the complexities of starting a new business, from name selection and document preparation to ongoing compliance support. With our comprehensive formation services, you can focus on building your business while we handle the legal details that protect your interests and set you up for success.