Business applications and formations continue to rise month over month in 2021. It’s a big step to start your own business and there are a lot of decisions ahead of you. One of the first decisions to make is what type of business entity to form. Previously, we discussed the following types of business entities: Sole Proprietorship, General Partnership and Limited Partnership. This article will define a Limited Liability Partnership (LLP). Rules vary by state, so for the purposes of this article, we are discussing setting up a Limited Liability Partnership in New York State.
The Definition of a Limited Liability Partnership
There are similarities between this business structure and other partnerships. The main distinction between this and the other partnership structures is that an LLP combines the advantages of a partnership with the benefits of a corporation. It limits liability for all of the partners, unlike a Limited Partnership which limits liability for only the Limited Partner. Partners are defined as those who have agreed to run the business together, have invested in the business and take money from the business as distributive shares (not a salary). A Limited Liability Partnership is most commonly used by attorneys, doctors and accountants. In some states including New York, an LLP can only be formed for such professional uses. The reason this structure is popular with professionals is because it protects them from being involved in a malpractice suit against another partner. An LLP must have at least two members.
The Advantages and Disadvantages of a Limited Liability Partnership
A Limited Liability Partnership provides many advantages, including minimized liability to the partners and reduced tax obligations.
- An LLP is a separate legal entity.
- An LLP may own property.
- Similar to a corporation, an LLP shields all partners from liability for the debts or actions of the company’s other partners or employees under other partners’ supervision.
- Members of an LLP manage the partnership themselves, according to the partnership agreement. They can decide how to divide managerial duties. This can also be seen as a disadvantage if there’s disagreement between partners on how to run the business.
- Partners share managerial duties and the company’s profits and losses.
- An LLP avoids double taxation. Each partner’s share of income and deductions are passed through to partners to be reported on their personal income tax returns..
- Partners who have financial interest in the company can elect not to have authority over business decisions while keeping ownership rights based on their percentage interest in the company.
- LLP’s are NOT recognized in every state. While some states limit the creation of an LLP to professionals, other states allow the formation of an LLP, but will impose heavy tax limits.
- There is a perception that LLPs have less credibility than corporations.
- If there is wrongdoing by a partner, that partner is still personally liable.
- An LLP can only be taxed as a partnership, unlike an LLC, which offers the options of being taxed as a corporation or S corporation.
- Individual partners are not obligated to consult with other partners in certain business arrangements. This is where a clear partnership agreement can help mitigate or avoid these issues.
- Financial statements must be disclosed publicly.
- An LLP can be dissolved by the death or withdrawal of a partner without partnership agreement.
How to Form a Limited Liability Partnership
As with all partnerships, you need to file the partnership in the state where you plan to do business. You will need to create a partnership agreement that clearly outlines how the partnership will be run and what each partner can and cannot do when making business decisions. For example, the agreement will outline what will happen if a partner is unable to perform his/her duties. Finally, it will lay out how the profits will be divided among the partners.
In addition, you’ll need to file a Certificate of Registration with the Secretary of State office. In New York State, within 120 days after the filing of the Certificate of Registration, the business must publish in 2 newspapers a copy of the Certificate or a notice related to the formation of the LLP and submit a Certificate of Publication.
What Tax Forms Does a Limited Liability Partnership File?
The profits and losses earned by the partnership will pass-through to the partners. Income taxes are paid by the partners in proportion to their share of the business at the partner’s personal tax rate.
The Partnership will file Form 1065 on the Federal level, which is an information return, so there is no income tax imposed at the partnership level. Each partner will receive Form 1065 Schedule K-1, which contains each partner’s share of activities for the taxable year. Each partner then reports the information on the Schedule K-1 on his or her Form 1040 and pays taxes at each partner’s individual income tax rate. The ordinary income passed-through from a LLP to partners is usually treated as self-employment income hence subject to FICA taxes, which is similar to social security and Medicare taxes for wage earners.
The partnership will be required to file state tax returns in the state where they are doing business. In New York State, the partnership will file a Form IT-204, which is again an information return. Each partner receives Form IT-204 IP, which shows each partner’s share of income and losses reported on the Federal information return, as well as income and losses that are apportioned to New York for NYS non-resident partners. The Form IT-204 IP also provides partners’ New York adjustments to Federal amounts due to the decoupling from Federal law by NYS and some other state additions and subtractions that are required by NYS. Partners then report appropriate information on Form IT-204 IP on their NYS individual income tax return, such as NYS Form IT-201 for NYS residents. Additionally, IT-204 IP lists the partner’s share of income earned in the Metropolitan Commuter Transportation District (MCTD) that is subject to the .34% Metropolitan Commuter Transportation Mobility Tax (MCTMT). If the partnership has income and losses from other states, non- resident K-1s will be prepared for those states.
If you have any questions about whether a Limited Liability Partnership is the right entity for your business, or about the requirements, please contact us.