Why an LLP is the Best Protection for Business Partners
By: Melanie Shires, PCC
Starting a new business with a partner is a decision that needs both clear understanding and intention. Forming a partnership is easy, it’s simply two people getting together to own and run a business. That being said, “simple” doesn’t necessarily mean “right.” If you and your partner are lawyers or doctors, two professions at high risk for malpractice lawsuits, a limited liability partnership, or LLP, may be the best structure to operate your business under.
With a basic partnership, the partners’ personal assets (e.g. home, car, personal bank account) are not protected against anyone demanding payment from the business. With an LLP, this is not the case and could be the best solution to protecting yourself and your other business partners.
What is an LLP?
An LLP is an unincorporated business owned and run by multiple people, all of whom share ownership and management responsibilities. These multiple partners enjoy limited personal liability for the business’s debts and the actions of the other partners.
This is extremely important because, despite efforts to do their jobs correctly, professionals may get sued when their clients aren’t happy with the outcome of their work. LLPs are commonly associated with businesses with licensed professionals, such as therapists and accountants.
Say for example, you’re an attorney and your clients disagree with your legal strategy, then lose their court case. They could sue you. Doctors are always at risk for a malpractice suit, which can be very expensive. If a patient dies under your care as their doctor a malpractice suit is inevitable.
As a partner in a law firm or medical practice, you have some control over your own risk for a lawsuit but little control over that of other partners. An LLP protects your personal assets from others’ actions and the actions of the partnership’s employees. However, limited liability does not protect each partner from their own professional activities.
Here are some of the advantages and disadvantages of an LLP:
You are liable only for your own actions and those of the people you directly supervise, not the actions of the other partners or the LLP. In other words, if the LLP gets sued, your personal assets aren’t at risk.
All you need to form an LLP is register with your state, pay filing fees and create a partnership agreement. You don’t need to create articles of incorporation and a board of directors, as with limited liability companies and corporations.
Individuals in an LLP are responsible for filing personal income taxes, self-employment taxes and estimated taxes for themselves. The LLP itself is not responsible for paying taxes. The credits and deductions of the company are passed through to partners to file on their individual tax returns. Credits and deductions are divided by the percentage of individual interest each partner has in the company. This can be beneficial for partners who have a limited interest in the company or special tax requirements due to their interests in other businesses.
An LLP offers partners flexibility in business ownership. Partners have the authority to decide how they will individually contribute to business operations. Managerial duties can be divided equally or separated based on the experience of each partner.
State Regulations Vary
Every state has slightly different laws regarding LLP registration, which can make it difficult to decide where and how to form one. For example, in some states you can only form an LLP if you’re a certain type of licensed professional such as an attorney, an architect, an accountant or a physician. Other states allow the formation of an LLP but will impose heavy tax limits on the entity, both when formed and ongoing. Additionally, regardless of the state in which they operate, many perceive LLPs to have less credibility as "true businesses" than corporations.
Special Tax Considerations
Due to the special structure of an LLP and extremely complex tax filing requirements, taxing authorities in some states recognize the structure as a non-partnership for tax purposes. This could possibly be a disadvantage for partners who require special tax consideration. Some states prohibit LLPs altogether because of the tax complexities.
Expensive Insurance Policies for Partners and LLP
Partners are responsible for their own liability and must each carry individual malpractice insurance. For some medical specialties in some states, premiums have been known to exceed $100,000 per year. The LLP itself also needs insurance.
One Partner Can Bind the Others
Individual partners are not obligated to consult with other participants in certain business agreements. For the protection of the overall integrity of the company, you should create a partnership agreement that specifically outlines what each limited partner can and cannot do when making business decisions. The financial statements of LLPs must also be disclosed publicly, which may create an issue for certain partners.
Steps to Form an LLP
Decide where to register: The requirements for forming a limited liability partnership vary by state, and some states offer more advantages than others. You can find information about specific state filing requirements through the Small Business Administration.
Register with your chosen state: You must register with a state agency (usually the secretary of state’s office) and pay a filing fee. When you fill out the registration application, you’ll have to include your company’s name and many states require that you include “limited liability partnership” or “LLP” in the name.
Get an employer identification number: You should get an EIN, employer identification number, which is a nine-digit number assigned to businesses for tax purposes. The IRS requires any business operating as a partnership to have one.
Get the proper licenses and permits for your business: If you need certain licenses and permits to operate legally, depending on your state, locality and industry. Use the SBA’s tool to find links to the relevant paperwork you’ll need.
Create a partnership agreement: An LLP agreement is a legal document that details the terms of your partnership. The agreement should outline the role of each partner, how profits and losses will be divided, how each partner can leave the LLP and how the partnership can be dissolved. You can create this document yourself using an online template or hire an attorney to help you create one.
Publish a notice in a local newspaper: Some states require LLPs to publish a newspaper notice to alert the public of their business’s registration.
In conclusion, an LLP can provide partnerships the right balance of legal protections and benefits. Forming yours in a way that best protects you and your business partners can be a wise business strategy.
As a business coach, I always encourage clients to consult with an attorney and/or an accountant as they are considering their options.
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