What is an LLP When it Comes to Taxes?
The government loves titles and long descriptive terms, so many things end up mostly being referred to by acronyms. When it comes to business formations or tax entities, LLP is the acronym for Limited Liability Partnership. In beginning to understand “what is LLP” in search results, it helps to understand the tax Partnership and Corporation entities firsti.
The Partnership Business Entity
A partnership, or commonly called a “general partnership” is a for-profit entity that is created by a mutual understanding of two or more parties. Better said, it is two or more people working together in a for-profit business. It can be as simple as a written agreement and a handshake.
The partnership is a pass-through entity for IRS tax purposes. This means that the profits of the business are passed through to the individual partners to be filed on their personal tax returns. The business files an information return with the IRS to show what was passed through to each partner, but the taxes to be paid are based on the tax rates for each individual partner.
Moving to the LLC, Limited Liability Company/LLP, Limited Liability Partnership
Unless those setting up an LLC, Limited Liability Company, specifically file a Form 8832 with the IRS, the LLC will be classified automatically as a partnership. The 8832 is to elect to be a corporation.
Both the LLC and the LLP have the major benefit of liability protection for the members or partners. By making it a limited liability structure, the owners/members/partners are shielded personally from liability for actions of the company. There are rules for reporting to retain the protected status, and these entities are filed at the state level and operate under state regulations.
The major difference between a simple or general partnership and the LLP is the liability protection. To start one, you can file for the LLC and without the Form 8832 to tell the IRS you want to be a corporation, your business will automatically be classified as a partnership. You file as the LLC, and you are operating as a partnership.
The More Formal LLP, Limited Liability Partnership
To be classified as an LLP, a more formal structure is required. There are annual reporting requirements and other requirements depending upon the state in which the LLP is filed. As a general partnership, all members of the LLP can participate in the management of the partnership.
Another type, and more limited, form of LLP is filed as a limited partnership. In this structure, one member has the management powers while others just share in the profits. As a partnership, the liability and risk would be shared by the partners, but when it is an LLP, that liability is greatly limited.
Professionals and Reputation
The LLP allows professionals such as lawyers and doctors to set up a business with shared profit goals and take advantage of the reputation of the individual members. They can share office space and other assets of the business among the partners. You will often see the LLP with names of some or all the members, such as Smith, Jones, and Burns, a Medical LLP.
The sharing of space, employees, and other assets allows the pass-through of higher profits. Those profits, as in a simple partnership, are taxed at the individual member level on their personal tax returns.
When there are people who have a common interest, are not direct competitors, and have a level of trust, the LLP is a popular and beneficial business entity structure.
i Publication 541 (03/2021), Partnerships – IRS.gov