When it comes to business there are a number of
purposes to form a limited partnership agreement.
Here’s how limited partnerships work.
A limited partnership (LP) is a type of partnership where one owner, the general partner, has unlimited
liability in the company. The other partner, the limited partner, only has a limited amount of liability in the
company as defined by the investment that partner has made in the company.
Understanding a General Partnership
By contrast, a general partnership is a partnership between two or more people where all the partners
have a stake in the business. When most people refer to a “partnership,” they’re referring to a general
partnership. The general partners aren’t truly separate entities from the business and business profits
are taxed at each partner’s tax rate. Each partner is liable for the business. If someone brings a lawsuit
against the business, they are actually suing the business partners who are then jointly liable for the
There doesn’t have to be a formal limited partnership agreement to form a general partnership, although
having a formal agreement does help solve disputes. If two people start doing business together, they’re
in a general partnership. To establish a limited partnership, legal documents must be filed with the state’
s secretary of state to establish the limited partnership. Without filing these documents, the partners are
all general partners and equally share in normal business management and the profits and losses.
How Limited Partnerships Work
The limited partnership is its own entity separate and
distinct from the rest of the business. The business
must have at least one general partner for any other
person to be a limited partner. The general partner
can be an individual, multiple individuals, or a corporation.
Limited partners aren’t involved in the everyday
management and operations of the business. They
also do not have the right to elect a board of directors.
They can typically participate in a decision liquidate the
business. The limited partner only funds money to the
partnership and the general partner(s) make all the
decisions about how that money is spent.
Limited partners aren’t personally liable for the business’ debts or lawsuits. However, since the limited
partner does have money invested in the business, that limited partner does stand to lose if the business
goes under. However, the limited partner has to be careful that they don’t become involved in the
business. Otherwise, they can be construed as more than a limited partner and held personally liable for
debts and other claims. State laws differ on how active the limited partner can be and still be considered
a limited partner.
When it comes to taxes, the limited partner claims business income on their personal taxes. But, this
income isn’t subject to self-employment tax, which is comprised of Social Security and Medicare taxes,
since that income was not earned income.
Family Limited Partnership
Families may form family limited partnerships where are the partners are family members. The FLP can
be used to minimize estate taxes since shares can be passed from one generation to another at a lower
tax rate. In recent years, the IRS has become more suspicious of people using FLPs to avoid taxation
and the agency has threatened to disregard this type of partnership. Forming a FLP has other
advantages. It allows the business to plan family successors and keeps some family members from
being personally liable for the business debts.
The only thing that really makes a FLP different from a regular limited partnership is that the members in
an FLP are family members. It’s the estate tax laws that make a FLP an attractive option for family
Limited Liability Partnership
Another type of partnership is a limited liability partnership (LLP), where all the owners have limited
personal liability in the group. This limited liability protects partners from being liable for another partner’s
actions. For example, a group of doctors might form a limited liability partnership so they each are not
held liable for a single doctor’s malpractice lawsuit. Some states have laws that restrict limited liability
partnerships to certain professional groups.
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