While most states permit anyone to form an LLP, this type of business is most commonly used by licensed professionals, such as lawyers and accountants. This is because, in the past, many professions were not allowed to incorporate because of public policy consideration about limiting liability for malpractice. The LLP permitted these professional partnerships to obtain some level of asset protection without tax consequences and without having to incur the costs associated with transferring assets from the old partnership to the new LLP. Some states, such as California and New York, restrict this business type of “professionals.”
How does an LLP differ from an LP?
An LLP is a form of business designed for the active management of the business. Thus, in an LLP, all partners have equal rights to participate in management—unless the partnership agreement provides otherwise. In contrast, an LP is designed to facilitate capital infusions from passive investors (the limited partners). These limited partners cannot participate in management. In an LLP, all partners enjoy some level of asset protection. So, in an LLP, partners typically aren’t liable for the debts and liabilities of the business or practice, although they are often required to have insurance policies to cover professional liability. In an LP, there must be at least one general partner who is personally liable for the partnership's debts.
How does an LLP differ from an LLC?
One of the most important differences between an LLP and an LLC is the degree of asset protection provided by the different business types. While there is a trend toward greater limited liability protection, in many states, the LLP still provides only a “limited shield” from the partnership’s creditors. This protection is considerably less than that available with an LLC. In addition, the partners in an LLP may have less protection from the claims of a partner’s personal creditors.
CT Tip. Many commentators noted that the rapid implosion of accounting giant Arthur Andersen, LLP following the Enron scandal was due to the limited shield provided to the LLP’s partners under the laws of its formation state. Since your business entity does not have to be created in the same state where you live or do business, it is important to determine which states offer the highest degree of protection, and create your LLP in one of those states.
Another difference is that an LLP is a partnership and must be taxed as a partnership. In contrast, an LLC can elect to be taxed as a corporation, which can provide for greater flexibility in tax planning.
How do you create an LLP?
To operate as an LLP, a general partnership simply registers as an LLP in their chosen state by filing registration documents and paying the required fee. Most states require that the LLP appoint a registered agent, just like an LLC or a corporation. Converting from a general partnership to an LLP is not considered a taxable event and none of the assets needs to be re-titled. Thus, the conversion is simple and inexpensive.