1. Limited Liability Partnerships.
  1. Introduction.
  1. Within the last few months, limited liability partnerships (LLPs) have effectively been approved as an acceptable form of doing business for professionals in the District of Columbia and 49 of the 50 states. The District of Columbia and 19 states have statutes that allow an LLP to be formed in their state, and they recognize LLPs formed in other states. Three additional states recognize the status of foreign LLPs (i.e., ones formed in another state) without having a domestic LLP statute. The remaining 28 states do not have specific LLP provisions but effectively allow CPAs (and presumably, other professionals) to use an LLP for public practice. (The only exception is Hawaii, where the status of LLPs is currently unclear.)
  1. The LLP concept actually arose in response to the huge personal liability problems faced by partners of law and accounting partnership in the last few years. Many of these problems had their origins in the multitude of malpractice claims related to the thrift and financial institution failures of the 1980's.
  1. Because most accounting and law firms have traditionally been structured as general partnerships, the personal assets of each partner are potentially exposed to all the malpractice liabilities of the firm. This is the case even when a particular partner had nothing to do with the client situation that results in the firm's liability for professional errors and omissions. The classic example of how devastating this can be is the story of the demise of the national accounting firm of Laventhol and Horwath. When L&H went under in the late 1980's, many of the firm's partners were forced to pay large amounts to settle the claims of the firm's creditors. In view of the L&H situation and several other significant law and accounting firm failures, it became very apparent that it really isn't "fair" to hold one partner financially responsible for the liability-generating errors and omissions of another partner. The LLP vehicle was proposed as a solution to this problem.
  1. What Is An LLP?
  1. Like the limited liability company, the LLP is a relatively new type of business entity. Unlike LLCs, however, LLPs can be viewed simply as a special type of general partnership that exists under applicable state law. The partners in an LLP normally remain personally liable for the entity's commercial liabilities (leases, accounts payable, etc.), and for liabilities related to their own professional errors and omissions, and for liabilities related to the professional errors and omissions of persons under their supervision. That's the bad news.
  1. The good news is that LLP partners are generally not liable for the professional errors and omissions of the other partners or most employees of the firm. Usually, the commercial liabilities of a firm can be managed satisfactorily. And, the individual partner can hopefully manage his or her own professional actions. Therefore, the use of an LLP adequately protects partners from the one type of liability that really strikes fear into the hearts of professionals--liability for the errors and omissions of other partners.
  1. This is clearly a better deal than the unlimited liability exposure that applies to partners in a general partnership. As stated earlier, with a general partnership, you may be called on to contribute personal assets to resolve firm liabilities created by the professional errors and omissions of your partners and employees of the firm.
  1. Operationally, LLPs are just general partnerships under state law with the above mentioned modification regarding personal liability for professional errors and omissions of others. As such, LLPs are subject to the general partnership nontax and tax considerations that you are already familiar with.
  1. Thus, the major tax advantages of LLPs are the favorable pass-through taxation rules that apply to partnerships and the flexibility that partnerships have to structure ownership interest with varying rights to cash flow, liquidation proceeds, and tax allocations. There will generally be no federal tax consequences associated with switching from general partnership to LLP status.
  1. As discussed above, the primary disadvantage of LLPs is the liability of the partners for the debts of the LLP (exclusive of liability for professional errors and omissions of others). Thus, an LLP clearly provides its partners with less liability protection than would be available to members of an LLC, but more than would be available with a general partnership.
  1. LLPs v. LLCs.
  1. From an overall liability limitation standpoint, the use of an LLC is clearly preferable to the use of an LLP. However, it seems very clear that LLPs are preferable to general partnerships. Therefore, LLPs are most attractive in states where LLCs cannot be used because they are not allowed for certain professional practices.
  1. Because an LLP is simply a special type of general partnership, the administrative aspects of converting to or adopting LLP status for a professional practice (for example, meeting the state board of accountancy rules) would be minimal in comparison to what may be necessary to obtain permission to operate as an LLC--especially if the practice is a multi-state practice. This is why the Big Six firms have all adopted LLP status.
  1. State tax considerations may also be important. For example, in Texas, LLPs are preferable to LLCs from a state tax standpoint. That's because LLCs are subject to the Texas franchise tax just like corporations, while LLPs are not. Where there is no state law disadvantage to LLC status, LLPs may eventually be displaced if state law and governing body rules allow professionals to practice as LLCs.