Limited Liability Company (LLC)
versus Limited Partnership (LP)?
Limited Liability Companies (LLCs) and limited partnership (LPs) are very similar. Both must be structured
and operated carefully to ensure that they are taxed as partnerships
for federal income tax purposes. Although LPs have been very popular
in the past, there are several reasons why LLCs are now the entity
of choice! Remember, with any rule there are exceptions.
CAUTION: The LLC can be taxed in four different ways. The Limited Liability Company (whether a Nevada LLC or an LLC in another state) MUST have the correct operating agreement to match the number of members AND taxation type.
An LLC can be taxed as a disregarded entity, S or C corporation or a limited partner. The federal IRS default rules that were established in 1997 that help determine how the LLC will be taxed.
Let's Compare the Limited Liability Company (LLC) and the Limited Partnership (LP) in More Details.
GENERAL PARTNER LIABILITY.
While a limited partnership is not subject to the tax code ownership
restrictions of an S corporation, a limited partnership must have
at least one general partner who or which is liable for all of
the debts of the partnership. In contrast, all of the members
of an LLC normally are protected from personal liability,
similar to limited partners.
Sometimes a corporation is used as a general partner
of the limited partnership to avoid personal liability. When an
LP has a corporate general partner controlled by the limited partners,
it is possible that a court could find the general partner to
be a sham if it is too thinly capitalized, or could permit the
general partner’s corporate veil to be pierced if its owners
ignore corporate formalities. Either of these could result in
an LP with no general partner, thus triggering possible liquidation!
This situation could not arise in an LLC where all members are
normally protected from personal liability.
Why You May Lose All Your
Assets in
a Limited Partnership!
In an LLC it is possible that over time a member
in an LLC, who was in the past receiving income not subject to
self-employment tax, changes their involved with the LLC, their
distributions will now be subject to self-employment tax. The
good news is they will not lose their limited liability! By contrast, a limited partner whose increased activity subjects them
to this tax may also run the risk of losing their limited
liability protection! This suggests a clear advantage to the
LLC!
It is important to note, however, that both an
LLC members’ interest and a limited partner’s interest are subject to charging orders against that interest obtainable
by creditors of the debtor member. Several cases have held that
the UPA permits the foreclosure of a limited partner’s interest.
[Madison Hills, Ltd Partnership II v Madison Hills, Inc., 35 Conn
App 81, 644 A2d 363 (1994); Centurion Corp v Crocker Nat Bank,
208 Cal App 3d 1, 255 Cal Rptr 794 (1989); but see Nigiri v Lotz,
216 Ga App 204, 453 SE 2d 780 (1995)]
The general partner owes limited partners the
duties of loyalty and care. In the terms of duty of care, courts
have been willing to borrow the business judgment rule from corporate
law and apply it in limited partnership contexts. [Levine v Levine,
184 AD 2d 53 (1992] Some model acts apply a similar standard [UPA § 21; RUPA § 404] Unless the partnership agreement provides otherwise,
the same standards will apply to limited partnerships. [See UPA
§ 6(2); RULPA § 1105] Given that general partners in a partnership
and managers in an LLC serve approximately the same function,
courts arguably should apply the same standard to the manager
of an LLC.
However, courts may find that limited partners may
require more protection because, by definition, they have limited
management rights whereas the members of an LLC have more participation
The general partner owes limited partners the duties of loyalty
and care. In terms rights in management and greater control over
the conduct of the LLC manager. [Ribstein and Keatinge on Limited
Liability Companies, § 9.09]
PARTICIPATION IN MANAGEMENT.
The participation of limited partners in the management of a limited
partnership can result in a loss of limited liability protection
for that limited partner. [RULPA § 303] No similar restriction exists on the ability of LLC member can participate in the management
and of the LLC. All LLC members can participate in the management
and control of the LLC, as members or as managers. [Uniform Act § 301]
RULPA has been revised, and the revision adopted
by several states allows greater participation by limited partners
in the management of the limited partnership.
An LLC has More Flexibility
Nevertheless, LLCs provide greater control, limited
liability to all members, and are simpler to form and maintain.
The degree of participation in management has
an impact on the degree fiduciary duties that partners in a limited
partnership and LLC members have between each other. Since limited
partners do not have management rights, the degree of fiduciary
duties owed by them to others is not as great as that of members
in a LLC. For example, limited partners may not be required to
alert partners of a business opportunity, which has a bearing
on partnership operations. [In re Villa West Associates, 193 BR
587 (D Kan 1996) (acquisition by limited partner of partnership
indebtedness which reduces that partner’s liability on a
guarantee relative to other partners without alerting other partners
of the opportunity was not a breach of fiduciary duty)]
To satisfy the minimum interest test, the general
partners collectively must have at least a 1 percent interest "in each material item of partnership income, gain, loss,
deduction, or credit… at all times during the existence of
the partnership, and the partnership agreement must expressly
so provide." The limited partnership does not violate this
representation by temporary lapses in compliance and failures
to comply due to conformance with Code Section 704(b) or 704(c).
Revenue Procedure 89-12 [1989-1 CB 798] reduces the minimum interest
test for limited partnerships with total capital contributions
exceeding $50 million.
Revenue Procedure 89-12 also provides that, the
general partners taken together must maintain a minimum capital
account balance equal to the lesser of: 1 percent of the total
positive capital account balances of the limited partnership,
or $500,000. A general partner does not have to satisfy this test,
if the general partner renders or will render substantial services
to the partnership in his, her, or its capacity as a general partner,
apart from services for which they are compensated with Code Section
707(c) guaranteed payments.
Because an LLC by statue has the corporate characteristic
of limited liability (as defined by the IRS), only in certain
circumstances, prior to the effectiveness of the "check-the-box"
rules, was any member of an LLC required to represent that it
had a minimum net worth or was entitled to a prescribed minimum
allocation of the LLC’s income.
How Should Your LLC be Taxed?
Call NCP and Find Out What the Best Option May be for Your Business!
Questions about Forming an LLC or Corporation?
Call NCP at 1-888-627-7007
