What Is A Limited Partnership? Definition, Pros And Cons (2024)

Business acumen and money are the two most important ingredients of any successful business. A limited partnership allows you to access the skills of a general partner and the financial investment of a limited partner. A limited partnership must have these two types of partners—general and limited.

The general partners bring the required business skills to the table, managing the business and making both big and small decisions to ensure its success. The limited partners invest in the business but are not responsible for managing it. An individual or a business could be a general or limited partner in an organization.

The liabilities of the partners depend on the management control they exercise. The general partners have unlimited liability for business debts and obligations while limited partners have a liability limited only to the amount they invested in the business. The general partners are responsible for their own actions and business decisions as well as those of other general partners.

However, don’t confuse limited partnerships with limited liability partnerships where all partners have limited liability. They can assume management activities but still have limited liability for business debts and obligations.

Pros and Cons of Limited Partnerships

A limited partnership is a pass-through entity, which means it does not have to pay taxes as a corporation. Instead, it informs the IRS about its profits, losses, deductions and credits via the IRS Form 1065. The limited partnership also issues the Schedule K-1 form to all its partners, reporting their share of the partnership’s earnings, losses, deductions and credits. The individual partners then add it to their personal tax return and file taxes accordingly.

Partners are liable to pay taxes on their share irrespective of whether the profits have been distributed or not. In case of losses, the partners can deduct the losses from their investments and reduce taxation liabilities. If their losses are greater than their investment, the loss can be carried over to the next year to offset the profits incurred in those years.

In the case of limited partners, their income or loss is considered passive because they are not involved in the day-to-day management of the business. Hence, the profit or loss due to the partnership can be used to offset other passive income streams only.

Limited partners do not have to pay self-employment taxes; only general partners have to do so. However, if limited partners are providing additional services to the partnership, for which they are receiving guaranteed payments, they need to pay self-employment taxes on that income.

All U.S. states, with the exception of Louisiana and the District of Columbia, have enacted some form of the Uniform Limited Partnership Act. As a limited partnership company, you must comply with the provisions of your state’s laws.

If you start a small business in partnership with other individuals or business entities without a formal registration, your business is deemed a general partnership, where all partners have unlimited liability to business debts. However, if you wish to form an LLC, you will need to formally create it, complete with a certificate of partnership identifying the general and limited partners.

Your limited partnership must hold investor meetings and allow all partners to inspect financial records and business books. Depending upon the state you are registered in, you may also be required to publish an annual financial report.

Forming a limited partnership is easy because it has a less formal structure and annual meetings are not required. Limited partnerships make it possible for business owners to gain fresh investments without diluting control.

Here are the most common scenarios where limited partnership should be the way to go:

• Family businesses: Also called family limited partnership, family businesses typically have multiple investors but few are equipped to run the business. In such cases, those who put up the required money are the limited partners whereas those designated to run the business are general partners. The management responsibilities can be passed on to the younger or next generation members who would eventually inherit the business.
• Professional businesses: In professional businesses such as law or accountancy firms, the senior partners may want to stay involved as limited partners. In such cases, they give up their management responsibilities to the general partners.
• Estate planning: If a parent or any family member holds real estate they eventually wish to pass on to an heir, they can start managing the real estate on behalf of the heir. The income produced is provided to the heir, who eventually holds full ownership when the stated terms and conditions of the limited partnership are met.
• Commercial real estate projects: This is the perfect use case for creating limited partnerships. Limited partners invest in the project and get a return after the project is completed. General partners are the organizers and managers of the construction and maintenance of the project.

A limited partnership is typically formed when someone has a business idea but lacks the necessary financial resources. They then try to find people who believe in the idea and are willing to invest in it.

These are the steps you must take to set up a limited partnership company:

1. Think of a business name that ends in “Limited” or “Ltd.” Ensure that the name is available legally in your state and not in use by another business.
2. Choose a registered agent who will accept legal documents on behalf of the partnership.
3. Decide upon the general and limited partners.
4. File the signed certificate of limited partnership with your state’s secretary of state office, giving these details: business name, business agent name and address, general partner’s name and address.
5. Draft a partnership agreement spelling out the rights and responsibilities of each partner. You are not legally required to do this but it comes in handy in case of future conflicts.

There are different kinds of partnerships you can form depending upon your business needs.

Here are a few alternatives to limited partnerships:

• General Partnership: Here all the partners share profits, losses and management responsibilities. All partners are fully liable for the debts and obligations of the business personally. They also owe fiduciary duties to each other and the partnership.
• Limited Liability Partnership (LLP): An LLP has no general partners. All the partners have limited personal liability for the tax and other business applications.
• Limited Liability Limited Partnership: An LLLP has both general and limited partners but even general partners have limited liability towards business debts and obligations. It is recognized only in some states.

When deciding upon the type of business entity, remember that general partners have full control over day-to-day running of the business and have full personal liability towards business debts and obligations. On the other hand, limited partners invest only money and hence have no personal liability beyond the amount they have invested. They also have no say in the daily management of the company.

A limited partnership has both general partners and limited partners. General partners bring their business expertise to the table and get 100% control over everyday management. In return, they are also fully liable for business debts and obligations. Limited partners invest just their money in the partnership and have no control over everyday management. This also means their liability to business debt is limited to the amount they have invested.