A Limited Liability Limited Partnership (LLLP) is a relatively new form of doing business and frankly gets a little too much hype in my personal opinion. Nonetheless, they are being used more and more frequently so I feel it a need to explain their usage, pros, cons, and why they are drawing so much attention.
The Basic Structure and Asset Protection
The LLLP evolved from that of the LP or Limited Partnership. Historically, and still according to a vast amount of case law and statutory law, the limited partners in a LP are not personally liable for the operations of the company and provide significant asset protection for said limited partners. However, in an LP, the general partner is liable and thus typcially this position is held by a shell/management company such as an LLC or Corporation.
The apparent beauty of the LLLP, is that this type of partnership also provides limited liability for the general partners of the limited liability partnership. This is unlike a limited partnership as I stated above, where the general partners are jointly liable for all obligations of the partnership. Thus, if one was so daring and interested in testing this law, an individual could apparently serve as the ‘general partner’ in an LLLP individually and be rest assured that they wouldn’t be personally liable for the operations of the LLLP. Not a risk I would generally want my clients to take. I feel that if an LP is warranted in a particular situation, then it is well worth the cost to have a shell entity serve as the general partner so there is an extra layer of protectionl and the risk isn’t born personally by my client.
The Tax Benefits
There are none. In fact, I think the the LLLP can cause tax problems if you aren’t careful. For example, from an ‘operational’ standpoint (or otherwise stated a company producing ordinary income), an owner will most certainly face self-employment tax. They only way to avoid this would be to have their share of the LLLP owned by an S-Corporation and funnel their profits through a properly formed and functional S-Corp Structure.
Next, heaven forbid you actually put rental properties into an LLLP. The IRS has been clear that in a Limited Partnership (and we can only presume this would be the same for an LLLP until we see further regulations from the IRS or Tax Court Cases), that passive losses in an LP are just that: passive. Even if you qualify as a Real Estate Professional, you can’t convert passive losses from an LP into ‘ordinary’ losses on your personal 1040. Rental losses should be funneled through an LLC for potential maximum benefit.
Thus, it is absolutely critical you consult with your tax professional before getting ‘sold’ on an LLLP simply because they are the next best thing to sliced bread in asset protection.
Which States Respect and Enforce LLLP Statutes
Another concern with the strategy of using an LLLP is that not every State has an LLLP statute and therefore the majority of States don’t officially recognize the LLLP’s asset protection provisions and nuances. Although one may think that one State would respect another State’s LLLP law under the Constitution’s Full Faith and Credit Clause, one should not be so naive. For example, every business owner or real estate investor knows it’s impartive to ‘register’ their entity in the State they are doing business either as its primary State for doing business, or as a foreign entity. Why does one do this? It’s to avail themselves of the statutory protection of the State in which they are doing business. But what if that State doesn’t have an LLLP statute and registration process? How does one register themselves as a ‘foreign LLLP’ if the State doesn’t officially recognize the LLLP form of doing business? The anwser: They don’t. The business owner in my opinion is throwing caution to the wind and hoping they receive this protection and begging to be the first test case to enforce the U.S. Constitution in their particular problem. Can I say the words expensive or unnecessary?
>That brings us to the States that actually do recognize the LLLP form of doing business. Currently, this list includes 22 States: Alaska, Arizona, Arkansas, Colorado, Delaware, Florida, Georgia, Hawaii, Idaho, Illinois, Iowa, Kentucky, Maryland, Minnesota, Missouri, Nevada, North Carolina, North Dakota, Pennsylvania, South Dakota, Texas, Virginia. Thus, if you really really need and want to use the LLLP as your business structure, I recommend you at least stick to the States listed above or stay away from the LLLP.
Why all the Hype?
Frankly, I will tell you why. It’s another ridiculous opportunity for promoters of overly elaborate structures to have something to talk about and sell to the masses. These promoters time and time again are not going to be around a year later to file the tax return and explain why the LLLP has reaked havoc on the owner’s tax plan, and moreover, they will certainly be long gone when a potential lawsuit arises and they are called upon to defend the structure.
You may ask yourself why LLLPs were even created or passed by State Legislatures as a viable and useful entity in the first place. Frankly I can’t explain why. The LP has historically been a fantastic entity for inside and outside charging order protection, in most states. Moreover, the LLP (Limited Liability Partnership) serves a fantastic entity specifically designed for licensed professionals and to be owned by S-Corporations for tax purposes. However, the LLLP just takes it one step further into the realm of absurd. I suppose if I had to guesss, I would think states that had a poor common law history of recognizing Limited Partnerships and their protection for Limited Partners, the legilatures may have wanted to take it upon themselves to implement a blatent and outright state statute to create ‘limited liability’ protection for it’s lmited partners under a bonafide law. Texas would be a good example of this when their common law for LP’s is generally weak, thus if you are in need of an LP in Texas, I would probably recognize an LLLP just for fun and enjoy some potential extra benefit.
Now a few words for my friends above the border. Canadian investors seeking to avoid the onerous ‘double taxation’ problem of using an LLC to hold their U.S. investment property will certainly want to and need to consider the Limited Partnership (LP) as a strategic entity for doing business. They receive signnificant asset protection, they can use a Canadian or US shell company as the general partner, and the issues of the real estate professional classifciation are irrelevant as they file under Canada tax law. They only time they would need to consider an LLLP is in States where LP common law protection is weak and an LLLP statute is on the books. So again, I pose the same concern and question as to why the LLLP is oversold and emphasized in certain investment and asset protection circles. In my opinion, it is simply a ruse to overcharge and overcomplicate the investors business structure to justify higher fees and give them a over embelished sense of security that doesn’t exceed that of a standard LP.
In summary, if you are truly interested in an LLLP, make sure to choose one of the 21 States with such statutes passed in their States and make sure and use a shell company as your general partner. After following standard asset protection operational procedures, you apparently should enjoy additional asset protection you would have never received under the standard LP statute. Lucky you. (By the way, at KKOS Lawyers, we charge the same amount for an LLLP as a LP or LLC)…go figure.
Mark J. Kohler is a CPA, Attorney, Radio Show host and author of the new book “The Tax and Legal Playbook- Game Changing Solutions For Your Small Business Questions” and “What Your CPA Isn’t Telling You- Life Changing Tax Strategies”. He is also a partner at the law firm Kyler Kohler Ostermiller & Sorensen, LLP and the accounting firm K&E CPAs, LLP. For more information visit him at www.markjkohler.com.