Partnerships traditionally have been preferred by many businesspeople for their simplicity and flexibility. However, many are concerned by the fact that partners are personally responsible for the partnership’s liabilities. Limited Partnership (LP) and Limited Liability Partnership (LLP) are business structures designed to help ease this concern. In both LPs and LLPs, some or all partners are insulated from personal liabilities, while still enjoying the pass-through taxation and flexibility of a general partnership.
LP and LLP mean almost the same thing, with the difference being whether limited partners can participate in management. These kinds of partnerships are generally designed for partners who are engaged in the same type of profession, such as a law firm or an accounting firm.
An LP is a form of partnership that has two types of partners: a general partner and limited partners. There has to be at least one general partner and at least one limited partner in every LP. The general partner manages the operation of the LP. In addition, general partners are personally responsible for the liabilities of the LP. They are entitled to their share of the profits, which is determined and agreed upon in the partnership agreement. Their role is the same as that of general partners in a general partnership. General partners can be natural persons or legal entities. Therefore, businesses often use an LLC or a corporation to be the general partner of the LP, providing personal liability protection to the owners.
Limited partners, on the other hand, only contribute to the business with their monetary investment. They are shielded from personal liabilities, but they can lose their financial investment in the LP. Limited partners have no voting power and no control over the operation of the LP. Limited partners receive payment for their financial investment, similar to a dividend paid to shareholders of a corporation. Limited partners can lose their status and be held personally responsible for business liabilities if they are found to be actively involved in the management of the business. Limited partners don’t have to pay self-employment tax as general partners do. This is because they only receive “dividends” for their share of investment in the business and they are not considered self-employed as long as they stay passive in the business operation.
An LLP is a form of partnership where all the partners enjoy limited liabilities. All partners are allowed to be involved in the management of the LLP. The procedures of operation can be spelled out in detail in the Limited Liability Partnership Agreement. Distribution of profits is also flexible.
LLPs are often preferred by professional service businesses, such as law firms, accounting firms and financial service firms. This is because partners of an LLP are not liable for the negligence or malpractice claims made against other partners. It is especially for this reason that some states do not allow licensed professionals to form an LLC. Even among the states that do allow this, some only permit certain types of professionals to choose the LLP structure. Founding partners can utilize the flexibility in management provided by an LLP to maintain control of the business, without having to give up too much say in the operation to junior partners. Unlike a general partnership, an LLP may be subject to state franchise tax.
Each state has its own rules governing the formation of an LP or LLP. Most commonly, you need to file documents with the appropriate state authority and pay the associated filing fee. The filing documents usually require some basic information, such as the name and address of the business, its agent for service of process and the nature of the business. Many states also require an annual report with updated information to be filed with the state.
What are the benefits of an LP or LLP?
There are pros and cons of starting a limited partnership or limited liability partnership. Some of the pros are, first and most importantly, limited liability for the limited partners in an LP. These partners can contribute the capital in a partnership without risking their personal assets. In an LLP, the liability is limited only for partners who did not participate in creating the problem or the debt.
Also, there is no double taxation in LP’s and LLP’s. Double taxation happens in corporations because the corporation pays income taxes on its profits, and then uses the remaining profits to pay dividends to shareholders, who again pay their own individual income tax on it. Thus, the same profit gets taxed twice. However, with partnerships, the partners themselves are taxed on their personal income tax returns for their share of ownership in the partnership, which usually amounts to less taxation.
What are the drawbacks of an LP or an LLP?
First of all, there is no limited liability for the general partner in an LP. There is also no limited liability for the partners in an LLP who participate actively in management and take big business risks. For either the general partner in an LP, or the risk-taking partner in an LLP, creditors can reach their personal assets. Second, the shares in a partnership cannot be publicly traded on the stock market. Publicly trading shares on the stock market is how most big companies go from small companies to large companies. For example, companies like Google and AT&T are publicly traded companies. This means that if you have an LP or LLP you limit your growth potential. However, your company can still become quite profitable, just likely not as enormous as Google and AT&T.
Finally, if limited partners in an LP try to become active in the business they risk being seen by the law as general partners, in which case, they too risk personal liability. Thus, if they want to always be seen as limited partners, they must not interfere too much in business operations, even if they disagree with the decisions of the general partner.
So is an LP right for an ambitious alien trying to start a business while at the same time protecting his/her personal assets ? Probably not. Such driven aliens usually have a vision and want to see it through. Thus, they’ll want management rights, which means they would have to be a general partner if setting up an LP. General partners do not have limited liability in an LP, so they put their personal assets at risk in business. In an LLP, such aliens will be actively participating in management, which means they will not have much limited liability. By actively participating in management, they will likely be the ones to bring on the debt, and their personal assets may be at risk to creditors. Ambitious yet cautious aliens will want to protect their families and personal assets in case their start-up businesses fail. They will want to take advantage of limited liability, but they will not be able to do that and also take active roles in management in either an LP or an LLP.
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