What is a Limited Partnership (LP)?

A partnership consisting of two or more participants is called a limited partnership (LP), not to be confused with a limited liability partnership (LLP). Limited partners do not manage the business; the general partner does all of the overseeing and running. However, a limited partnership has limited liability for debts up to the amount invested by each partner and unlimited liability for debts for the general partner.

A Brief Overview of Limited Partnerships (LPs)

Both general partners and limited partners are necessary for a limited partnership. General partners are entirely in charge of the company’s operation and are subject to limitless responsibility. In addition to having little to no management responsibility, limited partners’ liability is capped at the amount they invested in the LP.

Partnership Types

A partnership is typically a business in which two or more people own shares. Limited, general, and limited liability partnerships are the three types of partnership structures. While the three kinds have differences in several areas, they also have similarities.

Each partner in a partnership, regardless of kind, must provide resources—such as assets, cash, labor, or skills—to split the company’s gains and losses. At least one partner participates in the decision-making process about the organization’s daily operations.

Limited Company (LP)

An investment partnership is a limited partnership utilized as a vehicle for investing in assets like real estate. Unlike other types of partnerships, limited partnerships allow their members to have limited liability protection, which shields them from obligations incurred by the company beyond their initial investment.

In addition to being in charge of the limited partnership’s day-to-day operations, general partners are also accountable for the debts and legal liabilities of the business. Other donors, referred to as limited (or silent) partners, contribute money but are not liable for debts incurred after their original investment and are not permitted to exercise managerial control.

General Cooperation (GC)

A general partnership is one in which each partner has an equal say in management duties, financial obligations, and earnings. To prevent future disagreements, the partners should put their plans to divide earnings and losses unevenly in writing by creating a formal partnership agreement.

A joint venture is a general partnership that lasts until a project is finished or a predetermined amount of time has passed. Each partner has an equal say in running the company and a portion of its gains and losses. In addition, they have a fiduciary duty to behave in the venture’s and the other members’ best interests.

Partnership with Limited Liability (LLP)

A partnership in which each partner’s responsibility is restricted is known as a limited liability partnership (LLP). Participation in management activities is open to all partners. This is not the case in a limited partnership, where limited partners are not permitted to participate in management, and at least one general partner must have unlimited responsibility.

LLPs are frequently used to structure businesses that provide professional services, such as accounting and legal firms. LLP partners are not, however, liable for the wrongdoing or carelessness of their fellow partners.

How to Create a Limited Company

Established in 1916, the Uniform Limited Partnership Act has been revised numerous times and now governs limited partnership formation in almost all U.S. states. Except for Louisiana, these rules are enacted in 49 states and the District of Columbia, which comprises most of the United States.

To establish a limited partnership, participants must register the business with the relevant state, usually with the area’s Secretary of State’s office. Obtaining all necessary business licenses and permits is crucial and varies depending on the state, city, or sector. The U.S. Small Business Administration (SBA) maintains a list of every license and permit required to start a business at the local, state, and federal levels.

Partnership Contract

The limited partnership’s participants must create a partnership agreement and file external documents. This internal document outlines the business’s operational procedures. Each partner’s obligations, rights, and expectations are laid out in this agreement. This contract, referred to as the operating agreement, is not registered with any state or federal agency.

The partnership agreement should mention two of the company’s most critical financial features. The agreement should first specify how gains and losses will be allocated. This covers the partners’ share of the profits. Second, the procedure and requirements for selling a partner’s interest in the partnership should be specified in the agreement. A notice period or guidelines for the first right of purchase from other partners may be part of this.

Benefits and Drawbacks of Limited Partnerships

For limited partners, in particular, the main benefit of an LP is the limitation of their liability. Only the money invested in the LP is their responsibility. GPs may utilize these organizations to raise money for investments. LPs are a standard structure for hedge funds and real estate investment partnerships.

Since limited partners are not involved in the company’s day-to-day operations, they are exempt from paying self-employment taxes. Because limited partnerships (LPs) are pass-through businesses, their income is reported on their tax returns by the partners using Schedule K-1s that they get once the entity files Form 1065.

The disadvantage of LPs is that they mandate unlimited liability for the general partner. In addition to having complete management power, they are liable for debts and improper commercial dealings. Limited partners are also only permitted a restricted level of participation in operations. They are not protected from personal culpability if their role is determined to be non-passive.

Advantages

• Protection against personal liability for limited partners
• taxed as a pass-through corporation (i.e., not as a C-corp) and only subject to one tax
• Simple creation and reporting (no annual meetings, for example)
• Minimal formal framework
• Fewer taxes on self-employment for limited partners

Disadvantages

• GPs are personally liable indefinitely, even though they have managerial authority over the LP.
• Limited partners with restricted involvement in management
• Transferring ownership may be more complex than with other companies, like an LLC.
• Not as adaptable to changing leadership positions

LLC vs. LP

Limited partnerships and limited liability companies (LLCs) are comparable in a few ways. Both entities have some latitude in defining their membership roles and organizational structures. This involves managing each member’s voting rights, financial conditions, and fiduciary obligations.

Pass-through tax treatment is also applicable to both kinds of entities. This implies that every investor must include their portion of the entity’s earnings on their tax returns. The federal income tax does not apply to either LLCs or LPs.

Every legal entity differs in a few ways, beginning with the corporate structure. A limited liability firm may have as many members as it desires, whereas limited partnerships comprise general and limited partners. While limited partners of an LP are not permitted to be active participants, all members of an LLC often have the authority to control the company.

The liability component is another significant distinction. An LP’s general partners may be held personally accountable for all of the debts and liabilities of the business, as they have unlimited liability. Usually, limited partners are exempt from partnership responsibilities. On the other hand, LLCs frequently give their members corporation-like protection, meaning that they are frequently not held personally accountable for the obligations of the business.

Finally, LLCs are taxed with a bit more latitude. LLCs can be taxed as either a disregarded entity, a C corporation, or a S corporation. Partnership taxation is the default tax position for an LLC and an LP. LP consists of limited partners and general partners. Limited partners are not permitted to participate in day-to-day business management. Generally, general partners are personally liable for the business. Unless otherwise specified, all members of an LLC are entitled to participate in management. LLCs are taxed like partnerships. They are made up of owners who are frequently referred to as members. Often, members are not liable for the business. LLCs are subject to taxation as a disregarded entity, C-Corp, S-Corp, or partnership.

Taxes and Limited Partnerships

Regarding taxation, limited partnerships are handled similarly to general partnerships. Limited partners submit Form 1065 as an information return and are regarded as pass-through entities. Each member of the limited partnership is also given a Schedule K-1, which they use to record their respective portions of the business’s profits and losses on their tax returns.

Each partner may deduct any loss incurred by the limited partnership from their returns up to the amount of their participation in the business. If a partner’s loss exceeds their investment amount up to this point, they may additionally roll over their losses into subsequent years.

Passive gains or losses are profits or losses derived from a limited partnership. This results from the partners’ need for more active involvement in the company. Because passive activity can only be offset by other passive income and passive losses can only be used to balance passive gains, this is particularly significant from a tax perspective. This has a significant impact on self-employment taxes as well. Since they do not actively participate in the firm, limited partners are typically exempt from paying self-employment taxes on most payments; general partners, on the other hand, are typically required to do so.

What in business is a limited partnership?

Companies that create limited partnerships typically do so to hold or manage a collection of certain assets. Examples include partnerships for investment in real estate or LPs that oversee oil pipelines. In addition to having management duties and asset control, one party—the general partner—is also held personally accountable. Investors with limited personal liability typically comprise the other party, sometimes known as limited partners.

What distinguishes a limited partnership from an LLC?

LLCs and LPs provide flexibility in dividing duties, profits, and taxes. A limited partnership (LP) transfers all obligations to the general partners, leaving select investors (limited partners) free to make investments without managerial responsibility or personal accountability. The owners of an LLC are protected from personal liability, but they also typically have management responsibilities. A minimum of one limited partner is required for an LP.

LLCs are also more flexible when it comes to filing taxes. Since LLC managers are usually not held personally liable for the firms’ obligations, the general partner of an LP will frequently be organized as an LLC to help provide personal liability protection.

What distinguishes an LLP from an LP?

The structure of an LLP and an LP is comparable. LLPs lack general partners, yet LPs have limited partners and general partners. In an LLP, the liability of each partner is restricted.

What Is Taxation on Limited Partnerships?

Every participant in a limited partnership receives a Schedule K-1, which they must include on their tax return, as they are taxed as pass-through entities.

What Advantages Do Limited Partnerships Offer?

Limited partnerships are the best legal structures for obtaining money for a specific investment or collection of assets. They keep limited partners’ liabilities in check while enabling investment.

The Bottom Line

Because limited partnerships allow for capital raising without sacrificing control, hedge funds and investment partnerships typically employ them. Limited partners invest in limited partnerships (LPs) and are primarily responsible for their own money; they do not control the entity’s administration in any way. General partners oversee and operate the LP, but their liability is unrestricted.

 Conclusion

• A limited partnership (LP) is a business entity that requires at least one general partner and one or more limited partners.
• The general partner has unlimited financial liability.
• LPs are pass-through entities that have little or no reporting requirements.
• Most U.S. states govern the formation of limited partnerships and require entity registration.