What is a Limited Partnership?
Limited partnerships are a type of partnership which provide liability protection to one or more of the partners. In a limited partnership, there are two types of partners: general partners and limited partners. General partners run the day to day affairs of the business. They also have liability for all the acts of the partnership. In contrast, limited partners do not have a say in the daily operations of the business, but they also have no liability for debts, obligations, or other business requirements of the partnership.
Example of How a Limited Partnership Works
Mark and Todd decide to start a business together. They will run a brick oven pizza restaurant. Mark is enthusiastic about making the pizzas from scratch and managing the restaurant. While Todd believes the enterprise will work, he has a full time job as a pilot and cannot be involved in the day to day operations of the business. Because Todd will not be running the business like Mark, he does not want to have the same liability exposure. So Mark and Todd visit a business lawyer and the lawyer prepares a limited partnership agreement. This agreement names Mark as the general partner and Todd as the limited partner. Mark is able to run the business on a day-to-day basis like he wants and Todd is able to gain profits from the business but has no liability exposure from the operation of the company.
How is a Limited Partnership Formed?
To form a limited partnership in Tennessee there are very specific requirements that must be met. Most importantly, a Certificate of Limited Partnership must be filed with the Tennessee Secretary of State. This certificate must list the names and contact information for each of the partners and the business itself. It must also state which partners will be the general partners and which will be the limited partners. There must be at least one of each.
Once the certificate has been filed with the Tennessee Secretary of State along with a $100 filing fee, the limited partnership has been established and the business can start its operations as a limited partnership.
Pros and Cons of Limited Partnerships
As with any business entity, a limited partnership certainly has its advantages over a general partnership but it also has some drawbacks. Here are the advantages and disadvantages of the limited partnership.
Advantages of a Limited Partnership
The primary advantage of the limited partnership is its limited liability for partners who would rather not engage in the day-to-day management of the company. That is the distinguishing factor between a general partnership and a limited partnership.
Limited Liability for the Limited Partner
As compared to a general partnership, the primary advantage a limited partnership has is the liability protection that limited partners have. So for example, let's say that Frank wants to create an automobile repair business. Frank wants to get his hands dirty and actually repair the cars and run the business but doesn't have the money to open the business. But he knows that Sandra does have the capital. Sandra agrees to partner with Frank and front the startup cost of the business, but she does not want any liability with the operation of the business itself. All she wants is a share of the profits and a return on her investment. In this case, a limited partnership works well to accomplish the goals both Frank and Sandra seek. So if Frank incurs a substantial amount of debt or an employee gets hurt working on a vehicle, Sandra has no liability whatsoever. Only Frank does under those circumstances. Frank runs the business, makes money, and Sandra has a return on her investment.
Taxed at Personal Tax Rate, Not Corporate
As with general partnerships, the partners are taxed based up on their individual income tax rate, not any corporate rate. The limited partnership will not have to file a tax return and each partner will receive a K-1 for the business income.
Disadvantages of a Limited Partnership
Limited partnerships have several disadvantages that you should be aware of before deciding to create this type of business entity. These disadvantages are as follows:
General Partner Has Full Liability
In a limited liability partnership, the general partner holds all liability associated with the acts of the partnership. Certainly, if the limited partner goes rouge and causes issues himself, then the limited partner exposes himself to liability and threatens the liability shield of the partnership. But generally speaking, the general partner is fully exposed to any debts, obligations, or acts of the partnership.
Annual Reports Must be Filed
Under Tennessee law, the limited partnerships must file an annual report every year with the Tennessee Secretary of State. This annual report is required under the law to keep the liability shield in place for limited partners. The cost of filing this annual report is currently $20.00.
Self-Employment Tax for General Partners
General partners have an obligation to pay self-employment tax just as with a general partnership or sole proprietorship. However, limited partners generally do not have to pay this tax. Limited partners only pay self-employment tax if they receive guaranteed payments for services rendered to the partnership.
Tennessee Franchise and Excise Tax
The limited partnership must file a Franchise and Excise tax return each year unless the business is exempt from filing a return. There are two primary exceptions to the Franchise and Excise Tax: If 66% of the activities of the limited partnership are farming or possessing personal residences where at least one partner resides on the property.
If 95% of the limited partnership is owned by family and two-thirds (2/3rds) of the revenue of the business is passive income, such as renal income, or is farming.
In sum, if you are considering starting a business with one active partner who wants to run the actual business and one partner that is okay with providing assets without being involved in the daily business, a limited partnership might be a good fit for you.
Limited Liability Partnerships (LLPs)
Limited liability partnerships are another form of partnerships that exist in Tennessee. The primary difference between a limited partnership and a limited liability partnership (LLP) is that LLPs provide general partners a liability shield for acts of other members or employees of the partnership. Most of the time, LLPs are created for professionals such as lawyers, accountants, architects, or doctors.
Example of How an LLP Works
Craig and Sandy decide to open an accounting firm as a limited liability partnership. At first, the business is going well and the two are bringing in good income. After sometime, Craig discovers that Sandy has miscalculated several business clients' books causing massive problems with the companies. The clients sure Sandy for her malpractice. Because the firm is a limited liability partnership, Craig has no personal liability exposure for Sandy's mistakes.
Are Limited Partnerships or Limited Liability Partnerships Right for Your Business?
If you have questions as to whether a limited partnership or a limited liability partnership would be right for your business give Clarksville business attorney John W. Crow a call at 931-218-7800. John will be more than happy to speak with you about the different options you have in selecting a business entity and the pros and cons for each.