LLC vs. LP: Choosing the Right Business Structure

August 28, 2023
Business Operations
LLC vs. LP: Choosing the Right Business Structure

When starting a new business venture, entrepreneurs must weigh options for the legal structure and taxation of their company. Two of the most common options are limited liability companies (LLCs) and limited partnerships (LPs). While LLCs and LPs share some key characteristics, there are notable differences between the two entities in terms of management structure, liability protections, and tax treatment. This article explores the key features of LLCs and LPs, providing an in-depth comparison of the benefits and drawbacks of each business structure across three main categories. Business owners can use this guide to make an informed decision when choosing between an LLC or limited partnership for their new venture. The optimal structure will depend on the entrepreneur's specific circumstances and goals.


What are LLCs and Limited Partnerships?

Limited liability companies (LLCs) and limited partnerships (LPs) are two common business entity structures that provide owners with personal liability protection while allowing for pass-through taxation. While they share some key features, there are important differences between LLCs and LPs in terms of management structure, liability protection, and taxation considerations.

Key Differences Between LLCs and Limited Partnerships

LLCs have a more flexible management structure that allows all members to have a management role, while LPs designate general partners to manage operations and limited partners that are passive investors. LLCs offer greater personal liability protection for all members, while LPs expose general partners to unlimited liability. The taxation of LLCs is very flexible, with the option to choose corporate taxation, while LPs are pass-through entities that must report profits and losses on individual tax returns.


Legal Entity

A legal entity is a term used in business and law to describe an organization that is recognized as a separate entity from its owners. This means that a legal entity, such as a limited liability company (LLC) or a limited partnership (LP), is considered to have its own rights and liabilities, separate from those of its owners. In this article, we will compare LLCs and limited partnerships, highlighting key differences and discussing how each type of legal entity provides personal liability protection, as well as other important factors such as tax implications, management structure, and the types of partners involved. Whether you are considering starting a new business or looking to restructure an existing one, understanding the differences between these business structures is crucial in making informed decisions that align with your goals and priorities.

The Nature of a Limited Partnership

A limited partnership consists of one or more general partners and one or more limited partners. General partners are responsible for managing the partnership and have unlimited personal liability. Limited partners are passive investors with no role in running the business and their liability is limited to their investment. Forming an LP allows business owners to raise investment capital without giving up control of operations.

The Nature of an LLC

An LLC is a business structure that provides personal liability protection for its members while allowing pass-through taxation. Forming an LLC involves filing articles of organization, creating an operating agreement, obtaining licenses, and filing annual reports to maintain status. The advantages include personal liability protection, pass-through taxation, and operating flexibility, while disadvantages include higher setup costs and varied treatment across states.


Management Structure

A key consideration when choosing between an LLC and a limited partnership is how each structure deals with management roles and decision-making authority. LLCs provide flexibility for members to manage the business directly or appoint professional managers. In contrast, limited partnerships have a rigid separation between active general partners who manage operations and limited partners who have little control. The management structure has implications for liability exposure, as general partners in a limited partnership have unlimited personal liability for business obligations. LLCs allow even non-managing members to enjoy liability protection. Understanding the management and liability positions is critical for entrepreneurs to select the right entity for their goals and risk tolerance.


LLCs and Management Structures

LLCs can choose either member-managed or manager-managed structures. In member-managed LLCs, members oversee the company's daily affairs. In manager-managed LLCs, members appoint salaried managers to run the business. For multi-member LLCs, the management structure should be outlined in an operating agreement.

Licensed Professionals in a Limited Partnership vs. LLC

Licensed professionals receive different liability and management treatment in LPs versus LLCs. In an LP, they must serve as general partners, assuming full management duties and personal liability. In an LLC, licensed professionals can be regular members with limited duties and liability protection. When choosing an entity, licensed professionals should weigh their desired level of control against their liability risk tolerance.


Personal Liability Protection

A major benefit of both LLCs and limited partnerships is that they provide business owners with personal asset protection if the company faces lawsuits or debt. However, the extent of that liability shield differs between LLCs and LPs based on member status. When forming an LLC, every member is entitled to limited personal liability. But in a limited partnership, liability exposure is uneven - general partners face unlimited liability while limited partners' risk is capped at their investment.

For entrepreneurs concerned about safeguarding personal assets like houses, retirement accounts, or vehicles, liability protection is a key factor in choosing a business entity. Understanding the liability risks for different member roles can steer business owners toward LLCs or limited partnerships to best guard their personal wealth.


Limited Partnerships and Personal Liability Protection

In a limited partnership, limited partners enjoy liability protection similar to LLC members, but general partners have full, unlimited personal liability. Lawsuits and claims against the partnership can result in general partners' personal assets being pursued to repay debts and damages. Limited partners' assets remain protected beyond their capital contributions.

LLCs and Personal Liability Protection

One of the main advantages of LLCs is that they limit owners' personal liability and keep personal assets separate from the business in the event of lawsuits or claims. However, factors like inadequate startup capital, personal guarantees, and negligence can compromise liability protections. The level of protection also depends on individual state laws.

Taxation Considerations

Tax treatment is another point of differentiation between limited liability companies and limited partnerships. As pass-through entities, both report profits and losses on owners' personal tax returns rather than paying taxes at the business level. However, general partners in limited partnerships are subject to self-employment taxes while LLC members can avoid these. LLCs also enjoy greater flexibility in tax elections, being able to choose between pass-through taxation, C corporation status, or S corporation status. Limited partnerships are restricted to pass-through tax rules. For business owners, weighing pass-through benefits against self-employment taxes and the value of tax structuring flexibility can help inform the LLC versus limited partnership decision based on tax implications.


Limited Partnerships and Pass-Through Taxation

Limited partnerships are pass-through entities - partners report their share of profits and losses on their personal tax returns. General partners pay self-employment taxes on their shares, while limited partners' income is not subject to self-employment tax. The partnership must file an informational Form 1065 annually. Loss deductions for limited partners may be restricted.

LLCs and Pass-Through Taxation

As pass-through entities, LLC profits and losses pass directly to members' tax returns. This avoids double taxation. Limited Liability Companies (LLCs) are provided with the flexibility to choose their preferred method of taxation. They can file as a sole proprietorship, partnership, S-corporation, or C-corporation. This allows LLCs to select the most advantageous tax treatment.


When deciding between an LLC and a limited partnership, entrepreneurs should carefully consider their business goals, risk tolerance, and desired level of management control. LPs offer passive investors liability protection while general partners direct operations, but LLCs provide liability shields for all members while allowing flexibility in management roles. While LPs pass profits and losses to partners' tax returns, LLCs permit a choice between pass-through taxation and corporate taxation. There are advantages to each structure depending on the specifics of the business.

By understanding the key differences in management, liability, and taxes, business owners can determine if an LLC or LP is the optimal structure to achieve their commercial objectives while limiting risks and tax burdens. With the right information, entrepreneurs can choose the legal entity that best fits their venture.

State Filing Fee
Registered Agent
Prepared for Me
No items found.
Mentorship Icon

Business Courses coming soon! 

We are launching courses on entrprenureship, marketing, business operations, and SaaS. Sign up to receive an email about when the courses go live. We will be giving away copies of the courses to some of our email subscribers.