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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?
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