How to Understand the Disadvantages of a Limited Partnership

Limited partnerships can be a good choice for individuals who want pass-through taxation, a minimal amount of control and somewhat limited liability. The limited partnership differs from the limited liability partnership in that it operates much as a corporation with shareholders. The limited partner is paid "dividends" allocated by the general partner and enjoys freedom from the liabilities placed on the general partner. Still, the disadvantages associated with dense compliance requirements often discourage formation of limited partnerships. Read on to learn about the potential risks of a limited partnership.

Things You'll Need

• Experienced small business attorney or accountant

Instructions

1. Bear in mind that your partner, in a limited partnership, may transfer his or her share to a third party at any time, pending your first right of refusal.

2. Fail to file a renewal on time and lose your limited liability, due to the statutory nature of limited partnerships.

3. Be prepared to face the rigors of compliance with the centralized management of a limited partnership. For example, to take advantage of pass-through taxation for your limited partnership, you must meet a minimum number of criteria outlined on the IRS Web site (see the Resources section below).

4. Know that you must explicitly state your limited partnership status in any correspondence with outside parties or risk being in violation of federal securities law and vulnerable to a lawsuit.

5. Anticipate incurring the enduring expense of a highly experienced accounting professional to handle your limited partnership's IRS compliance requirements. This major cost disadvantage causes a good deal of small business owners to opt into a general partnership, corporation or sole proprietorship instead.

6. Understand that operational inefficiency is among the disadvantages of a limited partnership and frequently results in the decision to incorporate rather than form a limited partnership venture.

Tips & Warnings

• To save money, form a limited partnership with one of the many online services that handle incorporation and business formation. Limited partners are much like shareholders of a corporation in terms of both liability and control, and unanimous approval is often required before any business maneuver.

• Transfer shares at your own risk! Limited partnerships are considered securities, and investors involved in purchasing interest in such must be accredited as outlined by the Federal Trade Commission.