Limited Partnership vs. Limited Liability Company (LLC): What is the Difference?
Officially forming a business entity composed at the very least of more than one person will have you most likely looking at two choices.
Either you would look into forming a limited partnership (LP) or a limited liability company (LLC).
Both these options would be considered as solid choices.
A limited liability company and a limited partnership are both state recognized commercial entities in the United States of America.
Although they have certain similarities, there are important differences between a limited liability company and a limited partnership that will ultimately shape the decision to either form an LLC or LP.
It is these dissimilarities that would make one business entity more appropriate for specific circumstances over the other.
How does one decide and conclude on which option would be right for one’s business?
A handful of questions arise in regards to whether a limited liability company or a limited partnership should be established.
This article was made exclusively to help entrepreneurs with this decision.
You are in the right place if you are wondering whether to go for an LLC or an LP instead.
What is a Limited Liability Company (LLC)?
A limited liability company is a business entity that is owned, managed and operated by one or more people.
These people who own a limited liability company are also referred to as “members” of an LLC.
A limited liability company is a hybrid commercial structure that fuses the flexibility of sole proprietorships and general partnerships with the limited personal liability protection of a corporation.
The prime reason behind the surging popularity of establishing a limited liability company is its ability to provide something akin to a corporate veil while allowing the company to be a pass through entity.
What this means is that when the LLC is sued, its owners’ personal assets are shielded from collections, reimbursements or settlements.
Creditors can only go after the business’ assets.
The company’s financial obligations cannot be paid through the personal houses, properties, vehicles or bank accounts of the limited liability company’s owners.
This is a characteristic that an LLC has in common with a corporation.
On top of that, LLCs are pass through entities which many entrepreneurs find to be ideal for their income brackets.
Business owners can save a significant amount of cash on taxes when establishing a limited liability company.
This is made possible by the LLC being considered as a pass through entity which means that business owners claim profits and losses on their personal income tax returns.
There is no corporate taxation involved.
This is a characteristic an LLC has in common with a sole proprietorship and general partnerships.
What is a Limited Partnership ( LP ) ?
A limited partnership is a commercial entity that exists inside the American business landscape.
In order to form a limited partnership, at the very least two owners have to be present.
These owners need to operate on an unbalanced partnership model.
What this means for the business is that one owner will be recognized as the general partner while the other owner functions as the limited partner.
Companies that are composed of ownership groups that choose not to share equally in the responsibilities of running the business makes a limited partnership an ideal choice to consider.
The general partner operates on a level that is much more hands on as they are directly concerned and involved with the daily operations of the LP business.
On the other hand, the limited partner is also referred to as a silent partner as a result of their role in the business which does not involve being concerned with daily operations.
Limited partners do not have visible functions in the company.
The unbalanced partnership model works by freeing the limited partner from any liability of the company’s debt or its other financial obligations.
A limited partner’s role revolves around the amount that they have invested into the LP business.
It is through this kind of system that a limited partner’s purpose is that of a passive investor who will contribute funds to the company and in return gain a partial say in the major decisions that take place in the business.
Similarities of the Limited Partnership and the Limited Liability Company
When it comes to establishing a business entity, entrepreneurs often opt to form a limited liability company which makes it the more common option rather than that of a limited partnership.
There are similarities that limited liability companies and limited partnerships share from methods of taxation to flexibility in structure.
Limited liability companies and limited partnerships are both considered as pass through entities when it comes to paying taxes.
What this means is that both LLCs and LPs do not get charged on a corporate level that is inclusive of then being charged on a personal level.
What happens is that the profits and losses endured by the LLC or LP will go through the business structures itself and from there, individual owners or members will claim taxes on their personal tax income returns.
Due to the fact that limited liability companies and limited partnerships are not taxed on a corporate level, there is a significant amount that can be saved from the pass through entity tax structure that both limited liability companies and limited partnerships possess.
Corporations have detailed regulations that need to be strictly complied with even in regards to its ownership and management.
When it comes to limited liability companies and limited partnerships, the system is more flexible, allowing the owners freedom to make and adhere to their own managerial frameworks.
Advantages of the Limited Partnership
The most notable advantage of a limited partnership over a limited liability company is that it is significantly less difficult to attract investors to fund a limited partnership.
Venture capitalists do not find limited liability companies or limited partnerships an attractive entity to invest in.
Venture capital cannot be invested in a pass through entity.
However, when it comes to other kinds of investments, the limited partnership has clear advantages.
A limited partnerships’ unbalanced partnership model is composed of a limited partner that functions mostly as a passive investor which is an effective way to inject investments into the business without losing majority of the control over daily operations.
Limited partnerships have been around longer than limited liability companies and because of that, it is more consistent with legalities concerned.
Limited liability companies were not widely considered as a business entity in all 50 states before the 1990s which caused a lack in legal precedence of how courts regulate and treat limited liability companies.
Each state has its own laws and regulations for limited liability companies.
Limited partnerships on the other hand, being a business entity that was established over a longer period of time compared to LLCs, enjoy more consistency when it comes to legal precedent.
Limited partnerships also offer its owners several tax deduction opportunities that limited liability companies cannot offer to its owners.
Limited partnership taxation allows for the following deductibles: 401k expenses, health insurance costs, pension plan contributions and so much more. The aforementioned deductions cannot be applied to the taxation of a limited liability company.
Lastly, another notable advantage is the lack of self employment taxes for those that function as a limited partner. T
he limited partner does not pay the mandated 15.3% tax rate that make up the added employer and employee proportions of both Medicare and Social Security however, general partners and all limited liability owners do have to pay the 15.3% self employment tax.
Advantages of the Limited Liability Company
A key advantage of forming a limited liability company is the limited personal liability it grants to every single one of its owners.
This is in contrast to limited partnerships wherein only the limited partner has their personal liability shielded by the limited partnership business structure.
In the case of the general partner, operating the limited partnership will pose several risks.
While both LPs and LLCs are flexible business entities, limited liability companies actually allow the formation of an LLC so long as there is one person who will step up as the owner.
Limited liability companies are more flexible in the aspect of ownership unlike limited partnerships that require at least two owners who will function as a limited partner and a general partner in order to be legally established.
To add to an LLC’s ownership flexibility, it is permitted to adjust responsibilities and shares among owners as much as they would like.
The limited partnership’s business structure does not easily allow the same kinds of transitions to occur.
When it comes to a limited partnership, operations cannot continue if there is no limited partner and general partner.
In the event that a limited partner would like to become a general partner, it will not be as easy as the flexibility limited liability companies grant its owners.
Businesses That Use the Limited Partnership Entity
Limited partnerships are more popular in some industries than they are in others.
Businesses that typically opt to have a limited partnership fall under the law, accounting and financial investment industries.
Limited partnerships are particularly popular in the real estate industry.
It has come to the point that the term real estate limited partnership (RELP) was formed and is commonly used.
The popularity of real estate limited partnerships soared as it permitted development firms or property managers with years of experience to take control as the general partner while encouraging investments from limited partners who would not get in the way or clash with the management under industry experts.
Limited partnerships are also an attractive choice for family businesses as it minimizes their estate tax and gift tax compliance.
Forming limited partnerships for your family allows you to pass down your assets from generation to generation through gift tax exemptions granted to limited partnerships.
This has been such a widespread use of forming limited partnerships that it branched out to having its own term referred to as the family limited partnership (FLP).
Limited liability companies are the prevalent choice in forming official commercial entities.
Even though LLCs tend to outnumber limited partnerships, there are still types of businesses that benefit more from the structure of a limited partnership thus choosing to utilize the LP instead.
Those who find the unbalanced partnership model of a limited partner and general partner to be an advantage for their current circumstances would want to consider forming a limited partnership over a limited liability company.
Real estate businesses and companies that are owned by families would definitely benefit from having a limited partnership.
Something to take note of is that limited liability companies tend to be easier to form than a limited partnership with formation services available that specifically cater to limited liability companies.
It is completely acceptable to take the route of doing your own limited liability formation though it is usually not the most advisable step to take.
Business attorneys can be hired to form your limited liability company for you though the LLC in itself is relatively simple with less state mandated rules, compliance, and regulations to strictly comply with compared to a corporation therefore, the expertise of a business attorney will not always be called for.
To add to that, business attorney fees can get expensive especially in relation to the rather straightforward process of limited liability company formation.
Those who would still like their business to be professionally formed without the cost of a dedicated commercial lawyer can look into business formation services available in the market.
This article has hopefully helped in the beginnings of a thorough understanding of the differences and similarities between limited liability companies and limited partnerships.
With the information available, knowing whether to form an LLC or LP has been made easier.
Different businesses will have different operations and circumstances.
Fortunately, there are business structures available that serve as hybrids between flexible business structures and formal business structures that allow a more profitable outcome depending on the situation and commercial entity at hand.