Limited Partnerships: A Popular Business Structure with Pass-Through Tax Benefits
Limited partnerships (LPs) are a common legal structure used by businesses, especially for investment funds and family companies. Compared to a corporation, LPs provide pass-through tax treatment while allowing founders to maintain control. LPs are governed by state law which provides flexibility in structuring management and economics. This article will explore the benefits of limited partnerships and how they are formed and operated.
What is a Limited Partnership?
A limited partnership (LP) is comprised of one or more general partners and one or more limited partners. The general partners manage the business while limited partners contribute capital and have limited liability. LPs provide pass-through tax treatment – profits and losses flow through to partners' personal tax returns.
General partners have unlimited personal liability for debts and obligations, like in a general partnership. Limited partners enjoy limited liability like shareholders in a corporation. Their exposure is typically limited to their investment, barring any active management. This blend of active management by general partners and limited liability for passive investors makes LPs attractive.
In the US, LPs are creatures of state statute and governed by a state's version of the Uniform Limited Partnership Act. Partners execute a partnership agreement outlining rights and responsibilities. Key contents include profit/loss allocation, distribution policies, management authority, transfer restrictions, buy/sell terms, and dissolution processes.
Advantages of Limited Partnerships
- Pass-through taxation. No entity level taxes – profits and losses reported on partners’ personal returns.
- Limited liability for limited partners. No personal liability beyond capital contributions.
- Separate legal entity. Partnership can enter contracts, open bank accounts, etc.
- Flexible management structure. General partners manage while limited partners are passive investors.
- No limitations on partner types or numbers. Individuals, entities, trusts, and foreign investors allowed.
- Less administrative paperwork than corporations. No separate tax filings or formalities required.
- State law flexibility on economics and governance. Partnership agreement controls.
- Favorable estate planning characteristics. Transfer interests via gift/sale easier than corporate stock.
Common Uses of Limited Partnerships
LPs are commonly used for:
- Family businesses and estate planning. Limit liability and facilitate inheritance transfers.
- Real estate and investment funds. Limit investor liability and comply with securities laws.
- Startups seeking angel/VC funding. Incentivize founders with GP status and investors with LP status.
- Joint ventures and strategic alliances. Isolate liabilities between operating partner and financial partners.
- Oil and gas development projects. Allow outside investor participation in drilling projects.
- Professional firms. Limit liability for limited partners delivering professional services.
Forming a Limited Partnership
Forming an LP involves naming the entity, appointing a registered agent, and filing a Certificate of Limited Partnership with the state. Partners should also execute a Partnership Agreement defining partner rights and duties.
- Name - Include "Limited Partnership" or abbreviation like "L.P." at the end. Should be distinguishable from other names in state.
- Registered Agent - Must maintain a registered office and agent for service of process in the state. Typically a lawyer or corporate services company.
- Certificate of Limited Partnership - Filed with the Secretary of State. Lists general partners, address, purpose, etc. Filing fee applies.
- Partnership Agreement - Key governing document signed by all partners. Addresses economics, management, transfers, distributions, dissolution, etc. Can modify default state rules.
Ongoing Administration and Compliance
LPs require minimal administration compared to corporations. Key compliance areas include:
- Annual Reports - File with state annually. Verify agent and address. Fee applies.
- Tax Filings - No separate tax return. Income passed through to partners to report. May need to issue K-1s.
- Partnership Meetings - Not required by law but recommended. Document major decisions and amendments.
- Partner Changes - Update partnership agreement for changes in partners. File amended Certificate if needed.
- Record Keeping - Maintain capital accounts, partnership financials, tax info, meeting minutes.
Dissolving a Limited Partnership
LPs are meant to have perpetual existence. But they can be dissolved by:
- Partners voluntary vote per partnership agreement. Requires majority or unanimous consent.
- Partner withdrawal, death, or bankruptcy triggering dissolution under agreement.
- Judicial decree if pursuing business becomes impracticable.
- Administrative dissolution by state if annual reports or taxes not filed.
Upon dissolution, the entity wraps up operations, pays creditors, distributes remaining assets, and files a statement of termination. The partnership ceases to exist at the conclusion of this wind up process. Partners have no further liability except for claims against the defunct LP.
Get Legal Help Forming Your Limited Partnership
Limited partnerships provide excellent benefits as pass-through entities with limited liability for some partners. They are commonly used for family businesses, real estate ventures, funds, joint ventures, and more. Let's discuss if a limited partnership is the right structure for your new or existing business. Our business attorney can guide you through formation, drafting partnership agreements, ongoing compliance, and succession planning. Contact us today to schedule a consultation.