There are several types of partnerships, and each has its pros and cons.
From Your Multimillion-Dollar Exit, by Wayne Zell
What are the different kinds of partnerships?
The most basic form of partnership is a general partnership (GP). I walk up to you on the street, I know you, I shake your hand and I say, "Partner, let's be partners. Let's go invest in that real estate venture down the street." That's how simple it is to create a general partnership. A partner in a general partnership is personally liable for all business debts incurred by the partnership, even if they didn't agree to be liable for it. This refers to the concept of joint and several liability, which means that even though you were a 50% partner, you're liable for the whole debt if it's in the name of the partnership. So, it's risky to get involved in a general partnership.
Example: Your partner, Bill, goes out, signs up with the local bank, takes out a high interest rate loan in the name of the partnership. He proves that he's a general partner and the bank lends him the money without your knowledge or your consent. If the partnership is a general partnership, you're fully liable for the loan.
In a limited partnership (LP), by state law you must have at least one general partner (GP) and one or more limited partners. Limited partnerships are commonly used in real estate and investment ventures. The GP has unlimited liability for partnership debts, while the LPs usually only have liability for their investment or investment commitment.
There's also the limited liability partnership (LLP). LLPs are commonly used by professionals, such as accountants, lawyers, and sometimes doctors. In a professional LLP, a partner’s liability is limited to his/her own negligence and torts, as well as liability arising from individuals supervised by the partner. For other partnership debts (not arising from professional services), the partner’s liability is limited by his or her pro rata share of nonrecourse debts, but not malpractice liabilities arising from my partner’s bad acts.
Less commonly used is a limited liability limited partnership, which is a relatively new creature of state statutes and operates like a limited partnership. The key distinction is that you can limit the liability for a general partner in an LLLP if an election is filed and other requirements are met.
How are partnerships taxed?
Partnerships are basically pass-through entities, meaning that revenue minus expenses and certain other items such as credits and charitable deductions, are passed through to the partners.
So usually with a few state law exceptions, partnerships do not pay tax on their income. In recent years, states have enacted legislation allowing the partnership to pay a partner’s taxes. If the partnership generates losses, the partners may be limited in their ability use those losses on their individual tax returns. For example:
You are limited to your basis in the partnership, which equals the amounts that you contributed to the partnership plus whatever debts are allocated to you under the partnership provisions of the tax code.
You also must be “at risk” to claim partnership losses. This is a different standard that generally focuses on whether you are personally liable for partnership losses.
In addition, you may be subject to limitations on claiming losses under the passive loss rules, which were enacted in 1986 to curb the proliferation of tax shelters.
If you're not able to satisfy these three limitations, you can't claim the loss and the loss is suspended and carried forward.
Can you limit your liability in a partnership?
There are different ways to limit liability in a partnership. For example, in a limited partnership where you must have at least one GP, you can use a limited liability entity to serve as the GP. In that way, no one individual is liable for the partnership’s debts and their personal assets are protected. The different limited liability entities typically chosen to serve as a general partner include:
a limited liability company,
a corporation, or
an irrevocable trust.
Please contact a Zell Law attorney to learn more about how to use partnerships in your estate and business planning.