Limited Partnerships and Limited Liability Partnerships

Limited partnerships (LPs) and limited liability partnerships (LLPs) are both businesses with more than one owner, but unlike general partnerships, limited partnerships and limited liability partnerships offer some of their owners limited personal liability for business debts.

What Is a Limited Partnership?

In limited partnerships (LPs), at least one of the owners is considered a "general" partner who makes business decisions and is personally liable for business debts. But LPs also have at least one "limited" partner who invests money in the business but has minimal control over daily business decisions and operations. The advantage for these limited partners is that they are not personally liable for business debts.

The limited liability partnership (LLP) is a similar business structure but it has no general partners. All of the owners of an LLP have limited personal liability for business debts.

In order to better understand LPs and LLPs, it's helpful to compare them to general partnerships.

What is a General Partnership?

In the business world, the word "partnership" usually refers to general partnerships. A general partnership is a business that has more than one owner and that has not filed papers with the state to create a specific entity such as a corporation or limited liability company (LLC). (Click here to learn more about general partnerships.)

In a general partnership:

• all partners (called general partners) are personally liable for all business debts, including court judgments
• each individual partner can be sued for the full amount of any business debt (though that partner can, in turn, sue the other partners for their share of the debt), and
• each partner has "agency authority" for the partnership -- that is, each partner can bind the whole business to a contract or business deal.

How Are Limited Partnerships Different?

A limited partnership has at least one general partner and at least one limited partner. The general partner has the same role as in a general partnership: controlling the company's day-to-day operations and being personally liable for business debts.

The role of limited partners, however, differs in a few ways:

• Limited partners do not play an active role in the business. The limited partners (most LPs have more than one limited partner) contribute financially to the business (for example, a limited partner might invest $100,000 in a real estate partnership) but have minimal control over business decisions or operations, and normally cannot bind the partnership to business deals.
• Limited partners are not personally liable. In return for giving up management power, limited partners get the benefit of protection from personal liability. This means that a limited partner can't be forced to pay off business debts or claims with personal assets. A limited partner, however, can lose his or her financial investment in the business.
• Limited partners face slightly different tax rules. For income tax purposes, limited partnerships generally are treated like general partnerships, with all partners individually reporting and paying taxes on their share of the profits each year. Limited partners, as a rule, do not have to pay self-employment taxes; because they are not active in the business, their share of partnership income is not considered "earned income" for purposes of the self-employment tax.

Limited partners need to understand that they can become personally liable if they do not stick to their passive role. If a limited partner starts taking an active role in the business, that partner's liability can become unlimited. If a creditor can prove that a limited partner took acts that led the creditor to believe that he or she was a general partner, that partner can be held fully and personally liable for the creditor's claims.

Some states have carved out exceptions to this "active role in the business" rule. These exceptions usually allow a limited partner to vote on issues that affect the basic structure of the partnership, including the removal of general partners, terminating the partnership, amending the partnership agreement, or selling all or most of the assets of the partnership, without jeopardizing limited partner status.

What Is a Limited Liability Partnership?

Another kind of partnership, called a limited liability partnership (LLP) or sometimes called a registered limited liability partnership (RLLP), provides all of its owners with limited personal liability. LLPs are particularly well-suited to professional groups, such as lawyers and accountants. In fact, in some states LLPs are only available to professionals.

Professionals often prefer LLPs to general partnerships, corporations, or LLCs because they don't want to be personally liable for another partner's problems -- particularly those involving malpractice claims. An LLP protects each partner from debts against the partnership arising from professional malpractice lawsuits against another partner. (A partner who loses a malpractice suit for his own mistakes, however, doesn't escape liability.)

Forming a corporation to protect personal assets may be too much trouble. In addition, some states (including California) won't allow licensed professionals to form an LLC.

Limited Partnerships vs. LLCs

An LLC is similar to a limited partnership in that it provides liability protection to the owners of the business, and the owners have flexibility in deciding how the business will be managed. However, unlike limited partnerships, all of the owners of the LLC have limited liability protection. For more information, check out LLCs and Limited Liability Protection.

In addition, states typically have different formation paperwork for LLCs than for LPs. Further, while partnerships use partnership agreements to delegate rights and responsibilities, LLCs use operating agreements to outline the internal operating procedures.

To learn more about choosing between an LLC and an LLP, check out LLC vs. LLP: What Is the Difference?.

How to Create an LP or LLP

Creating a limited partnership or limited liability partnership is done at the state level. Each state has its own rules, but in general, you must pay a fee and file papers with the state, usually a "certificate of limited partnership" or "certificate of limited liability partnership." This document is similar to the articles (or certificate) filed by a corporation or an LLC and includes information about the general and limited partners. Filing fees for LPs and LLPs are similar to those for corporations and LLCs.

For more information on limited partnerships, including how to draft a limited partnership agreement, get Form a Partnership: The Complete Legal Guide, by Ralph Warner and Denis Clifford (Nolo).