A limited partnership is created by filing a certificate of limited partnership with the Texas Secretary of State.
A limited partnership does provide limited liability to its limited partners, such that each limited partner’s liability is limited to such partner’s interest in the limited partnership. However, the general partner of a limited partnership is personally liable for the liabilities of the limited partnership. Consequently, if the limited partnership will own assets giving rise to liability exposure, the well advised business owner will not serve as the general partner of the partnership, individually. Rather, such business owner will form another business entity such as a limited liability company or a corporation to serve as the general partner of the limited partnership, shielding the business owner from personal liability. When selecting a business entity to be used as the general partner of a limited partnership, most practitioners favor the use of the limited liability company over the corporation because the limited liability company provides business asset protection, which protects the assets of a business from the individual liabilities of its stakeholders.
Business Asset Protection
Like the limited liability company, the assets of the limited partnership are protected from the judgment creditors of the limited partners. If a judgment creditor of a limited partner seeks to satisfy such judgment with the limited partner’s interest in the limited partnership, the judgment creditor is treated as having the same rights as an assignee.
Piercing the Partnership Veil
Little authority exists on the issue of whether the partnership veil may be pierced so that limited partners are exposed to personal liability for the wrongdoings of the limited partnership. However, practitioners suggest that piercing the partnership veil is likely not a remedy available to the judgment creditors of a limited partnership.
As with any other type of entity, the structure of the limited partnership must be respected by its partners. If it is respected, then the limited partner’s personal assets will be protected from a lawsuit. To insure the protection afforded to the limited partners, the partners must adhere to the formal requirements of the limited partnership. This involves keeping all limited partnership income and expenses separate from the partner’s personal income and expenses.
Limited partnerships do pay Texas franchise tax. Federal partnership taxation is governed by Subchapter K of the Internal Revenue Code. The partnership is required to file Form 1065 and issue a K-1 to each partner, setting out each partner’s share of partnership net income or loss. The taxation of a limited partnership is often referred to as “flow through” or “conduit” taxation because net income and losses are not taxed at the partnership level, rather, net income and losses flow through to the partners and are reported by the partners on their individual income tax returns. While Subchapter S corporations and partnerships both offer flow through taxation, key differences make taxation under Subchapter K preferable in many cases. Partnership taxation offers unique flexibility with regard to the distribution of income and losses to the partners. Most of this flexibility springs from Section 704 of the Internal Revenue Code, which allows a partner’s distributive share of each income or loss to be determined by the partnership agreement. Therefore a partner’s distributive share need not be the same for each item. For example, an item producing income can be allocated to a partner with losses from outside the venture, and any item producing losses can be allocated to a partner with income from external sources. However, such allocation will be re-allocated in proportion to the partner’s interest in the partnership if the allocation does not have substantial economic effect. Subchapter S does not provide this type of flexibility in the allocation of income and loss. Another key advantage of taxation under Subchapter K involves the addition of partnership liabilities to the basis of the limited partners. Under Subchapter K, as the partnership takes on debt, each partner’s basis will be increased by such partner’s proportionate share of the debt. Again, Subchapter S does not allow the shareholders of an S corporation to increase their basis in the corporate stock when the corporation takes on liabilities. As a result, highly leveraged businesses prefer the use of the limited partnership over the S corporation.
Families often use limited partnerships for estate planning and asset protection purposes, as control of the partnership need not be tied to equity interests. In other words, control of the limited partnership may be centralized with one or more individuals or entities as general partner, yet the limited partners enjoy the profits of the partnerships. Additionally, businesses that are highly leveraged use the limited partnerships. Finally, the limited partnership is attractive to profitable businesses that plan to distribute most of the profits to investors.