How are limited partnerships taxed
A limited partnership (LP) consists of two or more persons, with at least one general partner and one limited partner. While a general partner in an LP has unlimited personal liability, a limited partner's liability is limited to the amount of his or her investment in the company. LP's are creatures of statute since they must file with the state to form them. Because of the limited liability of limited partnerships, they often are used as vehicles for raising capital. The limited partnership is a separate entity and files taxes as a separate entity.
The statute that provided for the formation of limited partnerships was the Uniform Limited Partnership Act (ULPA), which dates back to 1916. In 1976, ULPA was revised into the Revised Uniform Limited Partnership Act (RULPA), which was amended in 1985 to address the issue of limited partners' taking control.
RULPA states that a limited partner shall not be liable as a general partner unless he or she takes control of the business. However, a limited partner is not considered to control the business if he or she is a member of the board of directors.
Because the general partner is exposed to unlimited personal liability, LP's sometimes are set up so that the general partner is a corporation or an LLC.
Distinctions Between Limited Partnerships and General Partnerships
Three distinctions between limited partnerships and general partnerships are:
LP's are created by statute, not by intentions of the partners.
Ability to override the partnership agreement.
Tax treatment - a limited partnership normally has pass-through taxation, but must meet certain criteria to avoid being taxed as a corporation.
As in a general partnership, income can be allocated each year among the partners in a way that minimizes taxes. If the limited partnership meets a minimum number of criteria related to limited liability, centralized management, duration, and transferability of ownership, it can enjoy the benefits of pass-through taxation; otherwise it will be taxed as a corporation.
The limited partner interest is considered a security by law. It can be transferred to a third party, but general partners and limited partners have the right of first refusal. Because of its nature as a security, there is an advantage to targeting "sophisticated" or "accredited" investors, defined as those having a net worth greater than $1 million or having an income greater than $200 thousand for the past two years. Disclosure laws are not as rigid for such investors.
Two issues commonly faced by limited partnerships are defective filing and a limited partner's taking control.
A Case of Not Filing for Renewal
A potential problem with statutory entities is that if one forgets to file a renewal, one may lose limited liability without knowing it.
Case: Gilman Paint
& Varnish Co. v. Legum
The Tovell Construction Company was a limited partnership that was formed in 1942 for a predetermined duration of two years. C. Eugene Tovell and Walter J. Levy were general partners each of whom contributed $25,000 in capital, and Legum was a limited partner who contributed $150,000. Legum's share of the net profits was to be 33 1/3 percent. Gilman Paint & Varnish Co. sued Legum, together with Tovell and Levy, severally and as partners. In 1944 the partners signed a two year extension, but did not record it until 1948. Therefore, at the time of the sale of the merchandise, there was nothing on record indicating the existence of the partnership. In early 1948, the partnership defaulted, and Legum was sued for the amount owed.
Since the limited partnership no longer existed at the time of the sale, the issue is whether Legum really was a general partner and therefore whether he had unlimited personal liability.
Legum cannot be held as a general partner of the Tovell Construction Company. Furthermore, he did not have to give up his share of the profits in the business in order to not be held personally liable.
Section 11 of ULPA addresses situations in which a person erroneously believes himself to be a limited partner. If one gives up one's interest in the company upon learning of being a general partner, then the person is relieved of the obligation of a general partner. Section 11 of ULPA also states that one does not have to repay past profits as long as the profits do not exceed those that would have been received as a limited partner.
A Case of Limited Partners' Losing their Limited Liability
Case: Holzman v. de Escamilla
Hacienda Farms Limited was organized as a limited partnership in early 1943. Ricardo de Escamilla was the general partner and James L. Russell and H.W. Andrews were limited partners. Russell and Andrews advised Escamilla about which crops to plant and co-signed checks. They even could write checks without the need for Escamilla's signature. They also fired the general partner and hired somebody to replace him.
The partnership entered bankruptcy in December 1943. Russell and Andrews claimed that they had limited liability. The plaintiff maintained that they had taken control of the business, performing managerial acts, and therefore had the liability of a general partner.
The issue is whether Russell and Andrews active participation in the business made them lose the personal liability protection of limited partners.
Because they had the absolute power to withdraw all partnership funds from the bank account and could fire the manager, they had full control of the business and had become liable as general partners.Source: www.quickmba.com