Limited & Unlimited Liability – What’s the Difference & What you need to know!

Denise Elizabeth P
Senior Financial Editor & Contributor
Last Updated: July 8, 2021
Date Published: July 8, 2021

You may have heard of limited and unlimited liability and wondered what exactly that means, how they are different and what else you would probably need to know.

In the world of commerce, liability can be found everywhere which can shut down businesses in the worst cases and merely impede the progress of the businesses in the best case scenario.

It is for these reasons that limiting liability is what most business owners strive for.

Without the protection of limited liability, individuals are faced with unlimited liability when conducting business which means that the courts and regulating agencies can come after their personal assets from the cash in their savings accounts to their own homes and vehicles when settling, reimbursing or satisfying the liabilities or obligations that have been incurred during the operations of the business.

Limited liability happens when business owners form structures that are specifically designed to limit their personal liability.

Business structures like that of limited liability companies, limited liability corporations and limited liability partnerships exist to provide officers, directors, owners and employees the security and peace of mind to execute their jobs to the best of their abilities without dealing with the possibility of being sued personally.

Litigation’s run rampant which makes having a limited personal liability protection in place all the more vital for business ventures to progress and keep moving forward.

 

Articles of Organization

About Corporations

The longest standing means to attain limited liability protection when conducting business is by incorporating as a corporation.

A corporation is a business structure that allows the business to be considered as a legal entity of its own with several responsibilities and rights that are similar to that of an individual citizen.

Despite a corporation limiting personal liability, executives and directors of the corporation still continue their duties as the fiduciary of the corporation and its invested shareholders therefore they are still accountable for the proper management of the business for the sake of the interest of the business while being complaint with the state’s laws and codes of ethics.

Directors or executives who infringe upon their duties as the corporation’s fiduciary will still be held personally liable for their actions and the outcomes of those actions.

In any other event, every other individual involved in the corporation is still protected from facing personal liability which means that the mishaps, mistakes or lapses of judgement that transpire in the course of running the business under legitimate conduct will spare the individual’s personal assets from being affected.

Any debt that has been incurred and accumulated by the corporation will stay within the corporation as it limits the liability of its executives, officers, directors and employees which protects them from creditors coming after them for payment.

Limited vs unlimited liability

About Limited Liability Companies

Limited liability companies (LLCs) are identical to a corporation when it comes to its capability of protecting its managers, owners and employees from being held as personally accountable for the outcomes of conducting the company’s business.

In a limited liability company, the individuals that own the business are called members.

A member of a limited liability company can be another business entity including a corporation in addition to just being an individual member.

In several states, there is no upper limit or set number that dictates how many members a limited liability company must contain.

Limited liability companies are more flexible than corporations in the sense that there are no management structures required to govern it.

However, limited liability companies are not qualified like corporations to be traded publicly.

Come time for taxation, a limited liability company is considered as a “pass through” entity, thus it receives pass through tax advantages which is why it would be liable to pay a lower amount of taxes than if it was a corporation.

The limited liability company’s losses or profits get distributed to its members who can then file their shares of distribution on their personal income tax returns.

In the event that the limited liability company takes on a financial loss, each member can claim their own portions to that loss when filing their corporate or individual tax returns.

Limited liability companies can be sued but at the same time, LLCs possess the right to sue.

Limited liability companies protect each of its members from facing personal liability with the exemption of cases that arise due to an infringement of fiduciary duties.

A limited liability company is not recognized by the Internal Revenue Service (IRS) for tax filing purposes and so the LLC must be designated as a different business entity whether that be a sole proprietorship, partnership or a corporation.

A limited liability company has to be organized and formed through its presiding secretary of state or its relevant department of corporation’s offices.

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About Limited Liability Partnerships

A limited liability partnership (LLP) is a business structure that is composed of two types of partners with the first being a partner that is known as the limited partner while the other is the general partner.

A limited partner is also known as a silent partner and is not subjected to personal liabilities.

These types of partners are often investors who contribute funds into the business but are generally not concerned or involved with the everyday operations of the business.

Meanwhile, a general partner is in charge of managing the partnership and its daily operations while assuming full personal responsibility for it, thus being the one out of the two kinds of LLP partners to face personal liability.

Limited liability partnerships are frequently employed in professional fields such as architecture firms, medical group practices and law firms.

In certain states, general partners of an LLP can be corporations which allows the partner in charge of managing daily operations to also be free of personal liability.

An LLP’s limited partner can also actively work for the company which is usually the case in medical practices or law firms.

Likewise, they can also just choose to be silent investors.

The net losses and net profits that a limited liability partnership earns are distributed among the partners and passed through directly to the partner’s individual income tax returns with respect to their percentage of ownership.

An LLP partner cannot take in more loss or earn more profit than their proportion to the ownership of the limited liability partnership.

A limited liability partnership does not file their own income taxes; instead, they are required to file IRS Form 1065 which is an annual report that contains the data on the LLP’s losses and profits to the Internal Revenue Service.

A limited liability partnership is obligated to be registered through the office of the secretary of state.

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  1. IRS.gov "Limited Liability Company" Page 1 . July 8, 2021

  2. IRS.gov "LLC Filing as a Corporation or Partnership" Page 1 . July 8, 2021

  3. SBA.gov "Choose a business structure" Page 1. July 8, 2021