March 10, 2022 | Last Updated on: February 7, 2023
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One of the first steps to launching your small business or startup is to determine what type of legal entity you want it to be and how you will structure it. A limited liability partnership, or LLP, is an option when a business has two or more owners. In contrast, a single-member LLC is usually the way to go when a business has only one owner, but you can still form an LLC with multiple owners.
That said, the state laws surrounding LLCs and LLPs vary, and some states are better for incorporating your business than others. This article discusses which states are the best for registering your business as an LLP or LLC, as well as other things to consider when incorporating your company. But first, here’s a more in-depth look at structuring businesses as LLCs and LLPs and the benefits of doing so.
Before getting serious about your business (or getting a small business loan), you’ll need to choose a business structure. How your business is structured will affect everything from how you can operate your business to your tax liabilities to the level of risk you face concerning your personal assets.
As a small business owner, you’ll want to choose the best business structure for your company, one that offers a balance of benefits to you and your partners if you have any, as well as the best legal protection afforded for all partners involved.
Most small businesses in the U.S. register as a sole proprietorship, limited liability company (LLC), or limited liability partnership (LLP). Other business structures include corporation structures, such as S-corp, C-corp, and B-corp.
An LLC and an LLP have many similarities. Both are pass-through entities, meaning that for tax purposes, the business income of a business owner is treated in the same way as individual income tax. This helps the business owner to avoid double taxation, first through a corporate tax and then through their personal income.
An owner of an LLC is called a member, while the owners of an LLP are called partners. An LLP partner can be a general partner who actively manages the business, or they can be a limited partner that merely invests in the company but doesn’t manage the business.
In addition, an owner of an LLC or LLP typically has to pay self-employment tax to the IRS on the income received through their business and make Social Security and Medicare contributions.
If you register your business as an LLC, you benefit from personal asset protection if your business has a lawsuit filed against it or goes bankrupt. Your personal vehicles, home, and personal savings would be safe. LLCs are also taxed at lower rates than corporations are.
Both an LLC and LLP incorporation require that you file an article of organization or similar document with the Secretary of State or another designated office. An LLC document is called an operating agreement, while an LLP document is a partnership agreement.
The document should detail the duties of each owner, their responsibilities in the day-to-day operations of the business, how profits and losses are to be divided between the owners of the company, and what happens if an owner decides to leave the business.
Finally, you’ll also want to have a separate bank account for your LLC or LLP to ensure greater efficiency in maintaining financial statements for reporting purposes and taxes.
A limited liability partnership (LLP) is an option when a business has more than one owner. An LLP is a legal business entity that structures the company so that its partners are at least partially protected from the other partners’ liabilities, negligence, or debts. Legal firms, accounting firms, wealth management firms, medical practices, and architectural firms are often structured and registered as an LLP.
For a business to be structured as an LLP, it must have a minimum of two partners who have ownership or have invested in the company. In an LLP, each partner has a limited liability corresponding with how much they’ve invested in their company. This offers greater liability protection by spreading the risk among the partners.
Structuring a business as an LLP also prevents creditors from going after a partner’s personal assets.
An LLP is different from a general partnership. While general partnerships can be formed through a more informal verbal agreement, an LLP requires a more formal partnership agreement or written contract and reporting requirements that vary state-by-state.
Each U.S. state has its own regulatory rules and laws regarding LLP formation. As recently as 1992, there were only two states that even allowed LLPs. Fast forward to today, most states have adopted LLP statutes, but many states have restrictions regarding their formation.
One of the most significant differences between an LLC and an LLP is that all states allow most businesses to register as an LLC. But some states like New York, California, Nevada, and Oregon restrict LLP registration to specific professionals, such as attorneys and accountants.
The professional partnerships that benefit the most from an LLP are those most vulnerable to liability claims or lawsuits. Registering as an LLP helps to financially protect the more responsible members of a partnership if a member acts negligently or irresponsibly.
For instance, let’s say a legal firm has formed an LLP. One of the attorneys in the group is discovered to have given erroneous legal advice that leads to massive consequences. The remaining partners of the group are protected from any financial repercussions that may occur from a lawsuit directed at the attorney who erred.
However, the specific liability rules surrounding partners in an LLP varies by state. Some might only partially shield a partner from liability claims made due to the actions of another partner.
When deciding whether or not to incorporate your business, it’s best to research the state’s incorporation statutes where you plan to register your LLP or LLC. Corporate law, state fees, tax rates, and the overall cost to incorporate your business are different from one state to another.
Some states offer more advantages than others, particularly for specific business owners and professionals. Whichever state you choose to apply for incorporation, you’ll likely have to pay fees associated with filing for an LLP or LLC.
When you form an LLP or LLC in the same state where you’re doing business, it’s called a home state incorporation. Your home state may have continued requirements and fees as you conduct business. You’ll want to factor in those added costs to weigh the benefits of incorporation in that state.
Calculate how much revenue you forecast your company to bring in for the first few years once you incorporate your business, then evaluate how much tax over time will likely be required in the state you’re considering incorporating. Once you do that, one state may have clear advantages over another.
Some businesses decide to file for incorporation in a different state from their residence or place of business. If you decide that there are more advantages to incorporating in another state, you have to register to conduct business in that state. That is, you must apply for a foreign LLC or LLP.
Bear in mind that you must designate a registered agent for your LLC or LLP to be in a separate state than your business or where you live, and the agent must live in the same state you incorporate. The agent can be a registered agent service provider or a CPA or attorney who works for a firm with branches located across several states, including the state you plan to file for incorporation.
You’ll also want to investigate the state taxation laws surrounding LLCs and LLPs in the states you’re considering.
An LLC can be registered in any state, but there’s no doubt that some states offer more benefits or are simply better for forming or filing an LLC. The following are often recognized as the best states to incorporate a business.
Delaware is considered to be the best state for incorporation. The state attracts many small business owners in terms of filing for an LLP or LLC due to its lenient business law statutes. In fact, the Delaware Division of Corporations points out that almost 68% of Fortune 500 companies are incorporated in Delaware, many of them being LLCs and LLPs. Delaware offers a simple filing process, which might allow you to get your business going more quickly than you would in another state.
The initial filing fees and franchise taxes are also lower in Delaware than in many other states. It also doesn’t charge state corporate income tax for foreign-qualified LLCs and LLPs (businesses that don’t conduct business in Delaware but are incorporated there). There’s also no personal tax for incorporated business owners living outside Delaware.
Nevada is another state that offers significant advantages to forming an LLC or LLP. It doesn’t impose a state corporate income tax or personal income tax. It also doesn’t charge a franchise tax for LLCs or corporations, but it does have annual statement fees, business license fees, and initial filing fees. Most of the costs for filing an LLC or LLP in Nevada occur when you initially file, and there are lower continuing fees to incorporate in Nevada.
Wyoming is another LLC or LLP-friendly state. It doesn’t charge personal income or corporate income tax, and the reporting procedures required by the state are minimal. The state has a lower sales tax of 4%, and the LLC fees are also lower than other states. There is an annual franchise tax, when applicable, of $50.
The cost of starting an LLC or LLP is lower in New Mexico than it is in many other states. There are also no required annual report filing requirements of incorporated businesses to the state of New Mexico and no annual fees. The former is valuable in terms of time and money as many states have reporting requirements that allow them to collect more fees.
Alaska is considered one of the best places to form an LLC or LLP. Although some cities collect a minimal local sales tax, there is no sales tax or state income tax in Alaska. Some industries also qualify for tax credits, but this doesn’t typically apply to foreign-qualified businesses. To receive the tax credits, you generally must reside in and operate your business in Alaska. The state’s filing fees for incorporation are relatively nominal compared to other states.
California, New Jersey, and New York rank among the worst states to file or register for an LLC or LLP. For instance, New Jersey levies higher individual, corporate, sales, and property tax rates than many other states. It is also one of the most challenging states to do business in.
California has higher corporate tax rates and a hefty franchise tax of $800. The state also penalizes businesses that bring in more money. For instance, if the annual income of your business is more than $250,000, the state is likely to charge more fees, and if your business earns more than $1,000,000, California has a maximum individual income tax of 13.30%.
New York isn’t great either. It has an individual income tax rate of up to 8.82% and a higher sales tax rate. The state also bases its annual fees for LLPs and LLCs on the previous year’s gross income, which can be fairly high if your business does well.
Classifying your business as the right entity can potentially affect your bottom line and liability exposures. It’s vital that you thoroughly research the state where you’re considering registering your LLC or LLP. As you have seen, the LLC and LLP laws and rules vary from state to state.
If you already reside in one of the best states to file an LLP or LLC, you have less work cut out for you. Otherwise, you’ll want to be sure you have all of the facts surrounding state LLP and LLC requirements before choosing which state to incorporate your state.
It’s always a smart idea to discuss your options with your attorney or accountant before choosing where you will file for your business’s LLC or LLP.
March 20, 2023
