Many entrepreneurs operate under the misconception that they only have two options for formalizing their business structure: forming as an informal entity (i.e. a sole proprietorship or general partnership), or incorporating. While one of these two structures are often the ideal choice for a majority of businesses, there are a few more formal partnership options that may be a good alternative for specific types of organizations.
Limited partnerships (LP)
While the emergence of the LLC has all but eliminated the limited partnership (LP) as a common business structure, LPs are not completely obsolete. An LP is typically a prudent choice when forming a business that revolves around one short-lived project (e.g. film production, estate-planning, or event management). This is largely due to the fact that an LP allows for one visible managing partner who takes full liability for the business’s operations, while also allowing for a number of “silent partners” involved purely for investment purposes.
Much like more formal business structures, an LP must file with the state to become a recognized entity. This process is typically much less in-depth and faster than incorporating via a different structure. The most important information that you will provide to the state during incorporation is a complete breakdown of how much each partner has invested in the business. This is a necessary control that exists to ensure that the “limited partners” are only financially exposed for the amount that they have committed to invest at the partnership’s inception. They must also disclose their LP status by adding the abbreviation “LP” to their company name.
For tax purposes, the LP’s net income is allocated directly to each partner according to the terms set forth in the founding partnership agreement. However, the managing partner is typically allowed to deduct any fees or payments for the services he or she has rendered for the business first. As a result, the managing partner is also the only individual who is liable for self-employment taxes in an LP.
Limited liability partnerships (LLP)
The structure of an LLP is very similar to an LLC, with a few notable differences. An LLP caters specifically to professional service providers and practices. In fact, only certain types of organizations are even legally able to file as an LLP. The most common businesses that file under this structure are law practices, medical providers, accounting firms, and architectural companies.
The main purpose of an LLP is to create a working environment in which skilled professionals can be held liable for malpractice, but without endangering the finances of their associates. In the event that one partner is found at fault in a malpractice suit, only that partner’s assets can be collected to satisfy the court’s ruling (assuming there was no explicit hierarchical supervisory system in place). In some states, new LLPs are forced to form as a professional limited liability corporation (PLLC), but are still able to take advantage of many of the same benefits.
Despite the highly professional nature of the services that LLPs typically provide, forming an LLP is a relatively straightforward process that requires a single form to be filed with the state. Despite the ease of formation, there are a few regulations that must be acknowledged. In many states, a newspaper ad must be run for a certain period of time to announce a new LLP’s formation. This may seem like an outdated formality, but it is required nonetheless. All LLPs must consist of two or more partners who have all the applicable current licenses to practice their vocation.
For tax purposes, partners in an LLP are taxed on an individual basis for all of the company’s profits and losses. However, they are often required to pay self-employment taxes as well, though some exemptions to that rule exist (but are rarely granted).
Considering a professional corporation
If you are a professional organization, and looking to reform an existing practice, or start a new one, it may also worth be looking into the prospect of forming a professional corporation (PC). A PC typically allows for more flexible retirement planning for partners, which can be an exceedingly important benefit. PCs also carry the same malpractice liability protections for partners that LLPs do.
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