A limited partnership is a business entity that is characterized by two distinct types of owners – general partners and limited partners. General partners are the active managers of the business and (as in general partnerships) are personally liable for the obligations of the partnership, while limited partners (usually investors) act as passive owners who enjoy limited liability. In California, a limited partnership is created by filing a Certificate of Limited Partnership (Form LP-1) with the Secretary of State.
Below is a discussion of the characteristics of a limited partnership based on the factors to consider when choosing a business entity.
Limited Liability & Personal Liability
The limitation on liability of owners of a limited partnership depends on the type of owner. All limited partnerships must have at least one general partner. General partners are personally liable for the acts of the other partners done in the ordinary course of business and for any liabilities of the partnership as a whole (as in the case of general partnerships). Limited partnerships may also have any number of limited partners. Limited partners are essentially passive investors who do not partake in the management of the business. Limited partners enjoy personal liability and can only be held personally liable up to their capital contribution to the partnership. If limited partners do engage in management of the business, they risk becoming classified as general partners and losing their limited liability. It is common for businesses to use a limited liability entity (such as an LLC or corporation) as the general partner of the limited partnership, and therefore limit liability of all individuals involved. For example, investment funds will often have an LLC as the general partner of a limited partnership and have passive investors as limited partners.
Tax Treatment of Limited Partnership
In a limited partnership, as in a general partnership, there is no entity level tax. Rather, the profits and losses are passed through to the individual partners and are reported on the individual’s tax returns. However, limited partners are not subject to self-employment taxes based on the fact that the limited partner does not play an active role in the work of the business so limited partners’ income is not considered “earned income.”
As in a general partnership, the partnership itself does not pay income tax, but the general partner is still required to file an informational return on Form 1065 with the IRS. The business also must issue a Schedule K-1 to each limited partner to report the pass through profits and losses from the partnership on their individual returns.
Sources of Funding
As discussed above, the limited partners generally serve as the source of funds for a limited partnership. Thus, similar to a corporation, the limited partnership can raise additional funds through adding owners to the business. However, unlike a corporation, the limited partner owners in a limited partnership generally cannot engage in control of the business or they will risk losing their limited partner status (and their limited liability).
In California, to create a limited partnership, you must file Form LP-1 with the California Secretary of State, which includes a $70 filing fee. All partners involved in a limited partnership (both general and limited partners) must enter into a partnership agreement that will govern the relationship of the partners. Although this technically can be an oral agreement, a written agreement is very preferable as it will explicitly spell out the obligations and expectations of the partners. A limited partnership generally exists for the period of time specified in the partnership agreement, although any partner can request judicial dissolution of the limited partnership based on the grounds that it is not reasonable to carry on the activities of the partnership as described in the partnership agreement.
Contact us to discuss whether a limited partnership will be a good fit for your goals.
DISCLAIMER: The information in this article is provided for informational purposes only and should not be construed or relied upon as legal advice. This article may constitute attorney advertising under applicable state laws.