A limited liability partnership (LLP) is a type of business entity closely related to a general partnership. It offers more protection from personal liability than a general partnership, making it beneficial for accountants, attorneys, and other professionals whose practices face exposure to malpractice suits. Although designed with the professional in mind, nonprofessionals may be able to use this entity form, too, depending on state regulations. While it has similarities to a limited liability company (LLC), it is a different entity.
When Can It be Used?
If you and at least one other person want to form a business, an LLP may be a favorable option for you. For professionals concerned about possible malpractice exposure, the LLP offers personal liability protection not available in a general partnership. An existing general partnership of professionals, in fact, might convert to an LLP to gain greater liability protection for its partners.
Strengths
Offers More Liability Protection than a General Partnership
If you practice your profession as part of an LLP, you cannot be held liable if your partner is sued for malpractice. If you practice in a general partnership, you and the other general partners can share liability for an individual partner’s malpractice. Generally, if your business is organized as an LLP, you face personal liability only for your own negligence or that of an employee you directly supervise. In contrast, if your business is organized as a general partnership, you also face personal liability for the negligence of other partners and other employees you don’t supervise. Note that state LLP laws vary on whether this entity shields you from personal liability for contractual claims by the business’s creditors. Check your individual state’s law and consider consulting an attorney for guidance.
Offers a Close Alternative if LLCs Are Not an Option in Your State
In some states, either statutory law or professional licensing boards prohibit certain professionals from forming LLCs. Since LLPs offer similar protections from personal liability, they may be a satisfactory alternative in some of these situations. Consult an attorney for advice if you are located in such a state.
Forming an LLP May be Relatively Simple
Forming an LLP may be quite straightforward. Typically, you need to file an application with your state’s secretary of state or other appropriate office, pay a filing fee, and include the designation LLP or Limited Liability Partnership in the name of your company. You may subsequently need to file annual reports and pay an annual fee. Some states also require proof that the partnership has sufficient assets or liability insurance to pay potential legal claims against it. In addition, it is strongly advisable to have a written partnership agreement. (If you have an existing partnership agreement, you will need to review it and possibly amend it.) Check your state’s law and consult an attorney to find out your particular state’s requirements for an LLP. Seek the attorney’s input on other recommended steps in forming or converting to an LLP. Since LLPs are quite similar to general partnerships, converting a general partnership to an LLP is generally quite easy. Such a conversion, moreover, may not require the formal transfer of assets from one entity to another. In many states, you are not done with paperwork once the state has approved your business’s LLP application. You need to renew the application annually. Otherwise, your business will revert to a general partnership.
Pass-Through Taxation Avoids the Double Taxation Faced by C Corporations
Like partnerships, most LLCs, S corporations, and LLPs are pass-through entities. In other words, profits are taxed only once, at the individual owner level. The entity itself is not taxed.
Note: For tax years beginning prior to January 1, 2003, dividends were taxed as ordinary income. In an attempt to mitigate some of the burden of double taxation, various pieces of legislation provide that dividends received by an individual shareholder from domestic corporations and qualified foreign corporations are taxed at the rates that apply to capital gains. Most recently, in general, the American Taxpayer Relief Act of 2012 permanently extended the preferential income tax treatment of qualified dividends and capital gains, and established new rates for higher-income taxpayers. Capital gains and qualified dividends are now generally taxed at 0% for taxpayers in the 10% and 15% tax brackets; at 15% for taxpayers in the 25% to 35% tax brackets; and at 20% for taxpayers in the 39.6% tax bracket. Also, as a result of the Affordable Care Act of 2010, an additional 3.8% Medicare tax applies to some or all of the investment income for married filers whose modified adjusted gross income exceeds $250,000 and single filers whose modified adjusted gross income is above $200,000.
Tradeoffs
May Offer Less Liability Protection than a Limited Liability Company
While you avoid personal liability for the negligence of other partners, you nevertheless face more liability exposure than an LLC member. First, you generally face personal liability for the business’s debts and legal obligations. Second, you face potential liability for the negligence of employees you directly supervise in a professional LLP. The scope of liability protection is defined in the LLP statute of each state and varies considerably between states. Consult your attorney.
Example: Dr. John is one of five veterinarians practicing in a state that permits veterinarians to organize as either LLCs or LLPs. His veterinary assistant, Nurse Jill, negligently amputates a hind leg of a very famous dog from a TV series. If Dr. John’s veterinary practice is an LLC, he will not be personally liable for his nurse’s negligence. His exposure in relation to her negligence is limited to his investment in the LLC. If the practice is organized as an LLP, however, he could be personally liable for her negligence if he directly supervises Nurse Jill’s activities.
LLP Laws Are Less Uniform Among the States than Are LLC, General Corporation, and Partnership Laws
LLP statutes tend to vary more among the states than LLC, corporation, or partnership statutes. You need to study carefully your individual state’s law as well as the laws of other states in which you do business. This variation among states’ laws may make an LLP a less desirable choice for your business if it operates in several states. It should be noted, however, that LLC laws also vary significantly, though perhaps not to the same degree.
Transfer of LLP Ownership Interests Can Dissolve the LLP
If an LLP partner sells his or her partnership interest, the likely consequence is the LLP’s dissolution. A provision in the partnership agreement or the consent of all partners, however, might allow for the sale without dissolving the entity. This likelihood of dissolution may make transfer of LLP ownership interests more problematic than the transfer of shares of a corporation.
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