Often used where one or more partners (General Partners) actively operate the business, while others (Limited Partners) remain passive in the venture, contributing capital. There may be an unlimited number of Limited Partners but there must be at least one General Partner. The Limited Partnership requires a formal agreement and compliance with state statutes and provides liability protection to the Limited Partners to the extent of their individual contributions, but there is no liability protection to General Partners. This means a Limited Partner can lose her investment in the partnership, but nothing more than that. A General Partner, however, has unlimited liability for all of the debts and liabilities of the Limited Partnership. Typically, a Certificate of Limited Partnership is required, and failure to properly comply with state law means there is no limited liability protection for the limited partners.
Why would anyone agree to act as a General Partner in a Limited Partnership, and accept full exposure for the venture’s liabilities? Most often, the General Partner of a Limited Partnership is a corporation, whose shareholders enjoy the liability protection afforded by a corporation; thus, the shareholders actively control the management of the corporate general partner, and thus control the partnership, while only the assets of the corporation are subject to liability in the event of a financial disaster. A mere “straw man” cannot be used as the corporate General Partner, and such use will provide a basis to pierce through the limited liability protections to hold the Limited Partners fully liable. A Limited Partner loses her protected status if she becomes active in the operation of the business. A Limited Partner must not hold herself out as a “partner” of the Limited Partnership (she is a “Limited Partner”); doing so will cause the Limited Partner to become a de facto general partner.
A Limited Partnership files a separate tax return, Form 1065, although the partnership is not subject to federal taxation (generally, it is not subject to state franchise taxes and/or fees, either). The profits or losses of the business “pass through” to the partners’ individual tax returns with a Form K-1. The distributions passing through to the limited partners are considered “active” income and are subject to self-employment tax. In order for a limited partnership to pass muster with the Internal Revenue Service, care must be taken to avoid significant overlap in the ownership of the corporate general partner and the various limited partners; avoid a corporate general partner whose shareholders are composed of all the limited partners.
The partnership must include the designation “LP” or “Limited Partnership” in the name of the entity.