Article: Business Law – Limited Liability Partnerships

Introduction

One of the most important decisions any business owner faces is determining the legal structure for the business. For years, there have really been only two alternatives to choose from consisting of an unincorporated organization such as a partnership or sole proprietorship, on the one hand, or some form of corporation on the other hand. In choosing the right structure, the owner needed to evaluate, among other factors, which structure provided the best tax benefits and which structure provided the best liability protection. Unfortunately, in many situations the corporation offered the best liability protection, but produced unwanted tax results, while an unincorporated organization such as a partnership produced favorable tax benefits, but exposed the business owners to unwanted liabilities. In more recent years, many states have recognized this dilemma and created new types of entities intended to give business owners the best of both worlds. One of these new structures is the “limited liability partnership” which provides both protection of the business owner from liabilities created by his partner or their employees, and at the same time maintains the tax benefits partnerships have always enjoyed.

Partnership Basics

To incorporate, a business must file specific information in the form of articles of incorporation with the state for approval. Unlike incorporation, there are no formalities for establishing a partnership. In fact, partnership status can arise without the partners realizing they have created one. A partnership arises whenever two or more people co-own a business for profit and share in the profits and losses of the business. Each contributes something to the business, such as efforts, ideas, money or property, and each has equal management rights. If this structure is present, a partnership has been created.

Without a written partnership agreement, state law will govern the partnership. Under this law, a partner’s actions may bind the entire partnership. The partners have a duty to furnish information to the other partners, work on behalf of the partnership, and may not compete with the partnership. However, partners can agree to organize the business in whatever manner they please. If there is a written agreement, the partnership will be governed by contract law instead of state law. A typical partnership agreement covers the following:

a) duration of the partnership;
b) required and prohibited acts of the business;
c) individual partner contributions;
d) treatment of a partner’s outside business interests;
e) division of profits and losses;
f) limits on the authority of partners;
g) conditions for an individual’s addition to or withdrawal from the partnership; and,
h) a method for closing out the business upon dissolution of the partnership.

By whatever means a partnership has been formed, once it is created, all the partners are liable for debts and obligations resulting from the wrongful acts of another partner, if that partner acted in the ordinary course of partnership business, or acted with the authority of the other partners.

Limited Liability Partnerships

The advantage corporations have over partnerships is protection for the owners and operators against personal liability for the obligations of the corporation. Limited liability partnerships are a kind of hybrid in that they resemble a regular partnership in all respects except their allocation of liability. This it adopts from the corporate model. In a limited liability partnership, each partner is protected from personal liability arising from negligence, malpractice or improper conduct of other partners, agents or employees of the partnership. Some states limit the protection available and some states extend protection to all debts and obligations of the partnership. Still, even the most liberal limited liability partnership laws will not protect a partner from his or her own actions of negligence, malpractice or improper conduct.

Limited liability partnerships operate within the traditional general partnership structure. Thus, a limited liability partnership is taxed in the same manner as a regular partnership rather than as a corporation. This is significant because, unlike partnerships, corporations are seen a separate entities. This means that the corporation itself is taxed on its earnings. After that tax has been paid, the corporation may distribute remaining income in the form of dividends to its shareholders. These shareholders must also pay tax on this income, essentially resulting in a double tax on the income. Partnerships, by contrast, are not considered separate entities and, thus, pay no tax. Only the partners pay taxes. Losses also pass through the partnership to the partners. When the partnership loses money, the partners can deduct that loss from their other income to reduce their personal income taxes.

Existing partnerships that wish to take advantage of limited liability partnership status do not need to modify their existing partnership agreement, though they may choose to do so. A partnership simply files an application for registration as a limited liability partnership with the appropriate state agency. All states require disclosure of the partnership’s name and principal place of business. Some states also require, among other things, the number of partners, a brief description of the business, a statement that the partnership will maintain insurance and an acknowledgment that the limited liability status can expire. The shield only applies to claims that arise while the registration is in effect. Registration can lapse and must be renewed or the partners will become liable for any claims arising after the lapse.

Colorado and Limited Liability Partnerships

Colorado has taken a very liberal view towards limited liability partnerships. Any partnership is permitted to register as a limited liability partnership by filing a Registration Statement with the Secretary of State. Once a partnership has registered as a limited liability partnership, it will be required to file periodic reports with the Secretary of State, and the partnership must take care not to make distributions to the partners at times when the liabilities of the partnership exceed the fair market value of the partnership’s assets. However, if these relatively simple restrictions are complied with, a partner in a registered limited liability partnership should be protected from liabilities created by the partnership or by the acts of his partners or of other employees of the business.

Conclusion

The decision as to which organizational form to use depends on numerous factors, such as cost, relationships among owners, the need to limit potential individual liability and tax consequences. Limited liability partnerships are increasingly favored by those who desire the income tax attributes of a partnership without the exposure to liability associated with regular partnerships. A qualified business attorney can help you decide whether a limited liability partnership is right for you or whether a different organizational structure makes sense considering your specific business needs.

Preeo Silverman Green & Egle, P.C. AND OUR EXPERIENCE WITH LIMITED LIABILITY PARTNERSHIPS

The attorneys in our firm have a long history in representing all types of businesses including professional practices, manufacturing concerns, contractors, and manufacturer’s representatives, to name a few. We have the expertise and experience to analyze all the issues affecting business planning including tax considerations, liability issues, and practical issues involved in negotiating the purchase and sale of business interests and providing for the retirement, disability or death of a business owner. We have found that registered limited liability partnerships are the perfect answer for some businesses, but each situation is different and we can provide valuable assistance in sorting out the alternatives for any business. The specific attorneys who practice in this are: