What is a Limited Partnership for a Business?
Limited Partnership Compared to Other Partnership and LLC Types
Partnerships come in different types - limited partnership, limited liability partnership, and general partnership. And then there are limited liability companies (LLC's), some of which may be taxed as partnerships.
In this article, we'll look at the details of what makes a limited partnership and compare it to other types of partnerships and the limited liability company.
What is a Limited Partnership?
A limited partnership is a type of partnership with both a general partner and limited partners. The limited partnership was a popular partner form in the 1970s and 1980s, before the advent of the limited liability company (LLC) and other types of businesses. It still has some advantages today
What are Some Examples of Limited Partnerships?
LP's are often used for professional firms in which the professionals want to turn over management of the partnership to the general partner. Real estate investors also might use a limited partnership.
Another common use of a limited partnership is in a family business - called a family limited partnership. Joshua Kennon, Beginning Investing Expert, says that families often pool their money, designate a general partner, and watch their investments (hopefully) grow.
Limited partnerships are often formed as film production companies, to invest in real estate or other short-term projects.
Partners in a Limited Partnership
There is one general partner, who is responsible for the day-to-day management of the partnership. The general partner may be an individual person or an entity, like a corporation. Yes, a corporation can be an owner of a partnership.
The LP also has one or more limited partners. These individuals are sometimes called "silent partners," because they don't have to do anything except investing in the business to get a share of the profits.
Limited Partnerships and Liability
The general partner is also fully liable for the debts and liabilities of the partnership because the general partner has responsibilities and control and makes decisions that affect the partnership. This liability is for debts and also for lawsuits.
Limited partners have invested money in the partnership, but they don't participate in the management of the business. They are considered passive owners. Their liability is limited to their investment in the partnership, like owners (members) in a limited liability company (LLC).
Limited Partnerships and Income Taxes
Partnerships are pass-through business entities; the income tax of the business is passed through to the individual partners. Like other types of partnerships, the income taxes of the partnership business are paid by the individual partners, according to their partnership share. This share, called a distributive share, is passed through to the owner's personal tax return, and income taxes are paid at the individual's personal tax rate.
When the limited partnership has a loss, there's a difference in how the general partner and limited partners are treated for tax purposes. The general partner can take the loss even if the individual has no other income to offset it.
A limited partner has a passive income because he or she doesn't materially participate in the running of the partnership. This means he can't take a loss to reduce income taxes if there is no other income to offset this loss.
For example, if there is a $100,000 loss in a limited partnership for the year, split evenly between two partners: Joe, the general partner, and Sally, the limited partner. Joe can take a $50,000 loss, but Sally can only take her loss if she has other income to offset it.
How to Form a Limited Partnership
Like most businesses, you form your limited partnership by registering with your state. Your state may or may not allow limited partnership registration. Check with your state's secretary of state to see if this partnership option is available.
In addition to the registration, you will need a partnership agreement that spells out all the "what if" questions and the responsibilities of the partners. The agreement also details how the profits of the partnership are divided among the partners.
Advantages and Disadvantages to the Limited Partnership
The limited partnership has the same advantages as other types of partnerships with the option of limited partners; these partners can limit their liability while still participating in the growth of the business. Also, a limited partner who decides to participate in managing the business may find himself or herself liable for these management decisions.
The major disadvantage to the limited partnership is that the general partner must bear all legal liability for his or her management decisions. This person will need to be compensated adequately to offset these risks. In addition, the partnership agreement should include provisions that answer the question, "What if something happens to the general partner?"
Limited Partnership Compared to Other Partnership Types
Partnerships come in several different types. Some of these types may not be available in your state. Some states permit a limited partnership or other partnership variation, in addition to the more general partnership form. Check with your state's business division (usually part of the secretary of state division) to find available types of partnerships.
The limited partnership differs from a general partnership, which has only general partners who participate in the management of the business. All general partners have liability and they all can share in both profits and losses.
A limited liability partnership combines the characteristics of a partnership and a corporation. In this type of partnership, all partners are considered to be limited partners.
A limited liability company (LLC) with several members (owners) is taxed like a general partnership.