What is a Limited Partnership (LP)?
A Limited Partnership (LP) is a business arrangement involving two or more parties: at least one general partner who manages the business, and one or more limited partners whose liability is restricted to their investment amount. Differentiating an LP from a Limited Liability Partnership (LLP) is vital as these structures offer distinct advantages and responsibilities.
The LP structure is commonly adopted by individuals pooling funds to invest in real estate or other valuable assets.
Key Features
- Composition: Requires at least one general partner with unlimited financial liability and one or more limited partners with liability limited to their investments.
- Management: Limited partners have no role in management decisions.
- Taxation: LPs are pass-through entities with minimal reporting requirements.
Insights into How a Limited Partnership Works
In a Limited Partnership, general partners take the reins in managing the business while assuming unlimited financial liability. Limited partners, meanwhile, contribute capital but abstain from everyday managerial duties, and their liability is confined to their investment amount.
Many hedge funds and real estate investment funds utilize LP structures to shield investors from the risks associated with a failing venture.
Types of Partnerships
Partnerships generally involve business collaboration among two or more participants, commonly classified into:
Limited Partnership (LP)
Ideal for investors uniting resources to invest in assets like real estate. All management is centralized under general partners, exposing them to unlimited liability, unlike limited partners who hold no liability beyond their initial contributions and remain inactive in daily operations.
General Partnership (GP)
Every partner shares in profits, managerial duties, and liabilities. Each partner is equally engaged unless otherwise dictated by the partnership agreement. Joint ventures fit into this category, designed for targeted projects.
Limited Liability Partnership (LLP)
LLPs offer limited financial liability for all partners who may engage actively in management. They diverge from LPs by not mandating any general partner with unlimited liability. Widely favored by professional groups such as lawyers or accountants.
Formation of a Limited Partnership
Legal Framework
LPs must comply with most state regulations governed by the Uniform Limited Partnership Act, requiring registration typically done through the local Secretary of State’s office. Permits and licensing requirements can vary based on location and industry.
Partnership Agreement
Crafting a partnership agreement is crucial, detailing operational governance, profit distribution, management roles, and procedures for a partner’s withdrawal.
Advantages and Disadvantages of a Limited Partnership
Pros
- Limited personal liability for limited partners.
- Single taxation as pass-through entities.
- Simplified creation and lesser regulatory obligations.
- No self-employment tax burdens for limited partners.
Cons
- General partners bear unlimited liability.
- Limited partners prevented from participating in management.
- Transfer of ownership is typically more restrictive compared to other entities.
LP vs. LLC
Limited Partnerships (LP)
- Include general and limited partners.
- Limited partners refrain from management duties.
- General partners hold personal liability for operations.
- Taxation as partnerships.
Limited Liability Companies (LLCs)
- Composed of members without a personal liability for business debts.
- Typically tax-efficient, opting as partnerships, or possibly under C/S Corp. status or disregarded entities.
- All members generally have the managerial authority unless otherwise agreed.
Limited Partnership Tax Implications
LPs file Form 1065 with Schedule K-1 distributed to partners, who then report business income or losses on their personal tax returns. Potential deductions on personal returns from business losses are limited to investment amounts, with the opportunity for loss carry forward.
Passive gains and losses timing play a role in taxation; only offset by other passive income and typically not involving self-employment taxes unless for the active involvement of general partners.
Common Businesses Leveraging Limited Partnerships
Entities engaging predominantly in real estate or specialized investing often establish LPs, disassociating day-to-day managerial liability from passive investors (limited partners).
Differences between LLCs and LPs
LLCs afford all members the scope of limited liability with generally inclusive management roles. LPs, contrarily, balance liability and management between general and limited partners—handling liability personally while issuing no managerial responsibilities to the limited partners.
LLCs enjoy flexible tax reporting options, unlike LPs fixed underlying partnership income directives. An effective strategy is structuring an LP’s general partner as an LLC to avow liability protection.
Differences between LPs and LLPs
Both LPs and LLPs provide investor shielding through limited liability; however, LPs mandate general partners with limitless responsibility while LLPs uniformly share limited liability among all partners, fostering collective and secure coordination.
LLCs have broader tax treatment choices unlike LPs where each business activity assimilates agreement among tax filing predilection aligning precisely regulated prerequisites.
The Bottom Line
LPs remain quintessential for capital-driven enterprises seeking fortified liability segregation while converging operational control by general partners to incisively yield structured invoicing unanimously beneficial juxtaposition in optimizing collective professional discourse and investorial competency.
Related Terms: Limited Liability Partnership, Limited Liability Company, General Partnership.
References
- Cornell Law School, Legal Information Institute. “13 CFR § 107.160—Special Rules for Licensees Formed as Limited Partnerships”.
- CO- by U.S. Chamber of Commerce. “What Is a General Partnership?”
- U.S. Small Business Administration. “Joint Ventures”.
- U.S. Small Business Administration. “Choose a Business Structure”.
- Uniform Law Commission. “Partnership Act”.
- U.S. Small Business Administration. “Apply for Licenses and Permits”.
- Tax Policy Center. “What Are Pass-Through Businesses?”
- Internal Revenue Service. “LLC Filing as a Corporation or Partnership”.
- Internal Revenue Service. “Instructions for Form 1065 (2023)”.
- Internal Revenue Service. “Are Partners Considered Employees of a Partnership or Are They Considered Self-employed?”
