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are a form of business organization that combine attributes of corporations with those of partnership. Like corporations they can provide investors with the protection of limited liability. Like partnerships they can give management and the investors flexibility in allocating profits and losses among partners. The limited partnership, together with the limited liability company, is the structure most frequently used by venture capital firms to raise money. They enable investors to receive the profits and losses generated by the fund’s investment without the intervention of corporate income tax. At the same time, they give investors the flexibility needed to attract competent fund managers by funding their expenses and salaries and providing them with a percentage of profits for incentive. Limited partnerships are also used by young companies to transfer company losses to investors as a method of attracting equity investment (transferring losses reduces the investors’ after-tax cost of providing the equity). Limited partnerships have two types of partners, general and limited. Limited partners traditionally provide funding to the entity and, by virtue of their limited partnership status, receive limited liability much like that of a corporate shareholder. The general partners do not receive limited liability and customarily manage the business. Limited partners, unlike corporate shareholders, are generally prohibited from becoming involved with the active management of the partnership. If they do become involved, they risk being treated like general partners and becoming personally liable for the actions of the entity. Limited partnerships must be structured carefully. Obtaining the tax benefits of a limited partnership depends upon close compliance with Internal Revenue Service rules that govern, for tax purposes, the differences between corporations and partnerships. A limited partnership must qualify as a partnership to obtain the special tax treatment. There are generally four factors the Internal Revenue Service looks at when determining how to tax a limited partnership: 1) unlimited personal liability for the debts of the entity; 2) lack of centralized management; 3) limited duration; and 4) restricted transferability of ownership interest. If a limited partnership meets fewer than two of these standards, it may be characterized and taxed as a corporation. To avoid this result, limited partnership agreements usually try to qualify under criteria (3) and (4) by making the partnership terminate after a specified period of time and restricting the rights of limited partners to transfer their partnership interests. Whenever a limited partnership is used, management should consult with its attorneys and accountants. Only they can insure management of obtaining the desired tax results. See: R & D Partnerships, S Corporations. |
