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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.
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