Limited Partnerships

When choosing an organizational form for your business, be sure to consider the unique aspects of your operation.

A limited partnership (LP) is a partnership in which there must be at least one general partner who has unlimited personal liability, and at least one limited partner whose liability is limited to the investment he or she has made in the business.

To achieve limited liability for the owner who is assuming the general partnership interest, it was once common strategy to make the general partner be a corporation or LLC owned by the individual who otherwise would have directly owned the general partnership interest. Today, this once common strategy, which requires the creation of two entities, is obsolete. The same objective, limited liability for all of the owners, can be accomplished through the use of one entity--the LLC.

Limited partners are really "silent partners" who make an investment of capital in the way that a passive shareholder does in a large, publicly traded corporation. Along with the positive aspect of limited liability, limited partners have a negative to contend with, in that they are prohibited from making day-to-day management decisions. Because all of the owners usually want to participate in the management of the business, this is not a suitable form in most cases.

On the other hand, the fact that limited partners cannot participate in management means that this form can be useful for estate planning. Parent/owners who don't want to lose control of the business, but who want to reduce the size of their taxable estate, can transfer ownership shares to children in the form of limited partnership interests. (Actually, the same objectives can be accomplished with an LLC, but in that case all of the owners enjoy limited liability for the business's debts. Both objectives are discussed in more detail below, in the context of the LLC.)

Because the LP is not a taxpaying entity, losses from the business can be passed on to the owners' personal tax returns, where they can "shelter" or offset other passive income that the limited partners might have. The general partner's losses are not usually considered passive, so they can be used to shelter other income up to the value of the partner's investment in the partnership.

The LP can represent an effective shield for the owners' business interests against the claims of the owners' personal creditors. In many states, this can also be achieved in the LLC (but not in the corporation or LLP). In states where this is not possible in the LLC, the LP may represent a viable alternative to the LLC under the right conditions.

A recent Tax Court decision added to the growing line of cases that delivered both good news and bad news if you use an LP as a family wealth transfer device. The good news is the court found that the partnership was bona fide, that the liquidation restrictions were valid and that some substantial discounts for lack of marketability and lack of control could be applied in valuing the partnership interests that a father later transferred to his children. The bad news? The Court would not recognize extreme discounts that could never reasonably take place even for the most carefully constructed LPs. This line of decisions just proves further that, while LPs can be used for asset protection and estate planning, they do have their limitations no matter how carefully constructed.

Finally, states are beginning to allow the LP to register as an LLLP (limited liability limited partnership), in which all of the owners, including the general partner, have limited liability. This form is different from the LLP. The entity otherwise continues to be subject to the state's limited partnership law (usually the Revised Limited Partnership Act). This change will bolster the use of the limited partnership as an alternative to the LLC.

Do not confuse a limited liability partnership (LLP) with a limited partnership (LP). The LLP is similar to an LLC, in that all of the owners have limited liability (though the quality of this limited liability in the LLP varies from state to state). In contrast, in an LP, at least one owner must be a general partner, who has unlimited personal liability. Further, in an LLP, all of the owners can participate in management. In contrast, in an LP, limited partners are prohibited from participating in management.