The Limited Liability Partnership (LLP)

April 13, 2006

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When choosing a business form, you may want to consider the limited liability partnership (LLP), one of the newest entity options. While the LLP is similar to the limited liability company (LLC), there are some important differences that may make the LLP an inappropriate choice for the small business owner.

In many states, owners of an LLP have only a reduced form of limited liability from the claims of the business's creditors. This "limited shield," as it is sometimes called, does not afford the owners the same protection they would enjoy in either the LLC or the corporation.

In addition, in many states, the business interests of the owners of an LLP are afforded less protection from the claims of the owners' personal creditors, as compared to the LLC.

Finally, California and New York limit the use of LLPs to professionals, thus eliminating the LLP as a choice for other business owners. (In California, the term "professionals" is defined narrowly to include only lawyers and accountants, further restricting the availability of the LLP there).

Many years ago, the law prohibited professionals such as accountants and lawyers from operating in the corporate form. As a result, virtually all of the largest and oldest CPA and law firms in this country were formed and operated as general partnerships.

This, of course, meant that the general partnership had unlimited personal liability for all of the business's debts, but professionals who wanted to form a business with each other had no other choice.

When the law was finally changed to allow professionals to incorporate, many firms were reluctant to make the change for tax reasons, since the federal tax law deems a conversion from one form (partnership) to another form (corporation) a potentially taxable event. In addition, such a conversion would involve re-titling all of the firm's assets from the general partnership to the new corporation. These large general partnerships have offices in every major city in the country, hundreds of partners and millions of dollars of assets. Accordingly, the transfer process alone would be complex and expensive enough to dissuade these forms from making the conversion.

Similarly, it was believed that the Internal Revenue Service might deem conversion from a general partnership to an LLC to be a conversion to another form, and thus a taxable event. Through lobbying by accounting firms, law firms and other professionals operating in the general partnership form, the limited liability partnership (LLP) was developed.

The conversion process from a general partnership to an LLP is unique in the law. The general partnership simply registers as an LLP. Technically, the old entity does not dissolve, and a new entity is not created. The old entity continues to exist, but is now subject to a new set of laws (i.e., those governing the LLP). The conversion does not trigger a taxable event because there is no change in the entity. Moreover, because of this registration process, none of the assets needs to be re-titled, making the conversion especially simple and inexpensive.

The LLC vs. the LLP. An LLP is not the same form as an LLC. Important differences generally make the LLC a better choice for the small business owner.

While all of the owners of both an LLC and an LLP have limited liability from the claims of the business's creditors, in many states the quality of the limited liability is not the same.

Warning

Many jurisdictions only offer what is termed a "limited shield" in an LLP. In these states, limited liability protection is significantly reduced. These jurisdictions include:

States Offering Limited-Shield Liability Protection for LLPs
Alaska	Louisiana	Ohio
Arkansas	Maine	Pennsylvania
District of Columbia	Michigan	South Carolina
Hawaii	Nevada	Tennessee
Illinois	New Hampshire	Texas
Kansas	New Jersey	Utah
Kentucky	North Carolina	West Virginia

Since your business entity does not have to be created in the same state in which you reside or do business, it's best to avoid creating an LLP in one of these states.

Other states afford the LLP the same "full shield" protection as that enjoyed in the LLC and corporation. Because the LLP is so new, the law here is rapidly evolving. Expect more states to change the liability shield in the LLP from limited to full. For example, Florida made this change in 1999.

In addition, in many states, the business interests of the owners of an LLP are afforded less protection from the claims of the owners' personal creditors, as compared to the LLC. Specifically, an LLC can be formed in a state that protects the owner's business interest against the claims of his personal creditors. This is not possible with the LLP, as no state affords this protection to LLP owners.

Technically, the LLP is a partnership; therefore, it must have two or more owners. While states formerly required two or more owners to form an LLC, today one owner is sufficient.

The small business owner should generally avoid the LLP in "limited shield" states, because it offers less protection from liability there, as compared to either the LLC or the corporation. In addition, the IRS has clarified that an LLC would be treated like a partnership for tax purposes. Thus, today, a general partnership may be converted directly to an LLC tax-free. Accordingly, one of the main purposes of converting a general partnership to an LLP, rather than an LLC, no longer exists.

There is still one instance when an LLP makes sense: When the business owner is operating a very large, complex general partnership, conversion to an LLP rather than an LLC will be less expensive and less burdensome. Even here, however, it makes sense to form the LLP in a "full shield" state, even if that is not where the business's operations are conducted.

Where professionals operate in the LLP form, many states impose mandatory insurance requirements on the owners. These requirements are not usually imposed on the owners of an LLC, although this may be an oversight that will be changed in the future.