Well, last week, we addressed the advantages and disadvantages of a corporation (both subchapter S and C) and this week, our focus is partnerships. Here, you can operate as either a general or limited partnership. The focus there is on the amount of liability each owner wants.
A general partnership is a step removed from being a sole proprietor. The only difference between a sole proprietor and a general partnership is that the partnership will have a written agreement among the partners (although not required in Texas) regarding sharing profits and losses, management, dissolution and transfers of partnership interests. The general partnership can be made up of several sole proprietors, corporations or other business entities.
As with sole proprietors, the general partners are jointly and severally (collectively or individually) liable for all the entity’s debts and losses. For example, each partner could be liable for the other partner’s obligations and debts.
No state law filing is required of the general partnership and is thus the easiest entity to set up and dissolve. For federal income tax purposes, the profits and losses of the business entity flow through to each of the partners based upon their profit and loss share ratio set forth in the partnership agreement. Finally, a general partnership is not a preferred method to operate a business.
Next, a limited partnership is structured with one or more general partners and one or more limited partners. The general partner will have control over the day to day operation of the business and will most likely be a corporation, limited liability company or some other entity. The limited partner can be an employee of the limited partnership and maintain the limited liability status since the limited partner is working under the general partner. If the limited partner participates in the management, then the limited partner will lose its limited liability protection.
To set up a limited partnership, you must file for a Certificate of Limited Partnership with the Secretary of State and pay the fees (currently $750). Moreover, you will have the added step of setting up the general partner as a business entity—corporation or limited liability company and pay the fees (currently $300). Failure to file for the Certificate of Limited Partnership with the State of Texas defaults your limited partnership to a general partnership for state law purposes.
For tax purposes, the income of a limited partnership flows through to its partners upon their profit and loss sharing percentages. The partnership does not pay federal income taxes; however, still files a tax return. The income that flows through to the partners is not subject to self-employment taxes like in a general partnership. Absent some exceptions, the limited partnership is subject to the margin tax.
The limited partnership has been the preferred method for many companies; however, with the new margin tax, many loopholes are closing. Next week, we will address the limited liability company and the advantages it presents.
Editor's note: The information in this column is not intended as legal advice but to provide a general understanding of the law. Readers with legal problems, including those whose questions are addressed here, should consult attorneys for advice on their particular circumstances.
