When to Use an LLP
In short, I recommend never to use an LLLP. In all my years of experience as a professional tax attorney, I have never found reason to use an LLLP over other tax entities.
LLLPs have been adopted in over 20 states as a unique asset protection tool. However, they come with significant tax ramifications which far outweigh the advantages. If you are advised to start an LLLP, I strongly advise you to get a second opinion. Make sure to talk with your CPA about any tax benefits and drawbacks.
GP, LP, LLP and LLLP Meaning: What’s the Difference?
First, we have to understand how the LLLP fits into the family of partnerships.
General Partnership (GP)
The General Partnership (GP) is arguably the oldest form of doing business, dating back to two farmers agreeing to sell their products together at a local market.
A general partnership can be created with a contract or even a simple handshake. More recently, they are created with two emails agreeing to work together. Both partners are liable for everything. GPs do not provide any asset protection or tax advantages without additional structuring.
Limited Partnership (LP)
In an LP, the Limited Partner puts up the capital and the General Partner does the bulk of the work.
The Limited Partner isn’t personally liable if something goes wrong. Say, for example, someone slipping in front of a banana stand. In this situation, the Limited Partner may only lose their capital investment. The General Partner, however, is liable for everything in an LP, leading to many issues.
A separate entity would need to be set up to protect the General Partner. Not to mention, real estate investors’ losses are frozen as passive losses, even if they’re a real estate professional. Lastly, income-producing property is a tax planning disaster.
Limited Liability Partnership (LLP)
Then the Limited Liability Partnership (LLP) began in Texas in 1992. Now, over 40 states have some form of an LLP statute. There is no General Partner in an LLP. Hence, no one is liable for the operations of the LLP. Limited partners are not personally liable for business debts. They are liable for their actions if negligent and/or acting out of the scope of the purpose of the LLP.
The LLP was created for lawyers, accountants, doctors, architects, and other professionals. Each state gets to decide which professionals can use them. Unfortunately for real estate investors, they do not qualify for LLPs.
Limited Liability Limited Partnership (LLLP)
The LLLP was designed to completely eliminate the automatic personal liability of the general partner for partnership obligations. Under most statutes, it also eliminates the “control rule” liability exposure for all limited partners.
According to the 2001 Uniform Limited Partnership Act (ULPA), “general and limited partners benefit from a full, status-based liability shield that is equivalent to the shield enjoyed by corporate shareholders, LLC members, and partners in an LLP”.
The Basic Structure and Asset Protection of the LLLP
The LLLP is a relatively new form of doing business. The apparent advantage is that this type of partnership provides limited liability for the general partners of the limited liability partnership. This is different from a limited partnership as I stated above. In an LLP, the general partners are jointly liable for all obligations of the partnership.
Thus, an individual could apparently serve as the “general partner” in an LLLP individually. Rest assured that they wouldn’t be personally liable for the operations of the LLLP. I would not advise my clients to take this type of risk.
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. Then there is an extra layer of protection, and my client limits their risk with established asset protection and tax law.
LLLP Tax Benefits and Challenges
In my experience, the LLLP has no tax benefits. In fact, if you aren’t careful, it more often causes tax problems. For example, from an “operational” standpoint (or otherwise stated a company producing ordinary income), a business owner will most certainly face self-employment tax with an LLLP.
The only way to avoid this is 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.
The LLLP presents even more issues for real estate investors. The IRS is 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 critical to consult with your tax professional before committing to an LLLP. In my experience, it is almost certain a different entity will serve you better.
What are the disadvantages of LLLP?
LLLP Statues and State Law
Bear in mind not every state has an LLLP statute. Most states do not recognize the LLLP’s asset protection provisions and nuances. Do not assume that one State would respect another State’s Law under the Constitution of Full Faith and Credit Clause; this is not the case.
It’s imperative business owners “register” their entity in the State in which they are conducting business, either as its primary State or as a foreign entity. This is to ensure a business owner is availed of the statutory protection of the State in which they are doing business.
How does one register themselves as a “foreign LLLP” if the State doesn’t officially recognize the LLLP form of doing business? In short, they cannot. In this case, the business would be taking a chance, hoping they receive this protection.
This could result in the highly unnecessary and expensive problem of them becoming the first test case to enforce the U.S. Constitution.
Which States Recognize the LLLP?
The following 22 states recognize the LLLP as a form of doing business:
- Alaska
- Arizona
- Arkansas
- Colorado
- Delaware
- Florida
- Georgia
- Hawaii
- Idaho
- Iowa
- Kentucky
- Maryland
- Minnesota
- Missouri
- Nevada
- North Carolina
- North Dakota
- Pennsylvania
- South Dakota
- Texas
- Virginia
Why the Hype Around LLLPs?
An LLLP is an unnecessary entity, and the problems it typically presents far outweigh the advantages. However, it has been well-promoted. Remember, these promoters will not be there to help you when it comes time to file your tax return.
Historically, the LP acts as a fantastic entity for inside and outside charging order protection in most states. The LLP serves as a great entity specifically designed for licensed professionals and for S-Corporation tax purposes.
An LLLP has no advantage over these other two types of entities. So why the hype? If I had to guess, I would believe it may have been created by legislatures intending to implement an outright ‘limited liability’ protection statute for its limited partners under a Bonafide law. This would only be advantageous in states with a poor common law track record of recognizing limited partnerships and their protections for limited partners. For example, Texas, where common law for LP’s is generally weak.
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How do LLLPs Work for Canadian Investors?
Canadian investors seeking to avoid the onerous “double taxation” problem of using an LLC to hold their U.S. investment property have been known to use the LLLP strategy, typically created in Delaware, Florida, or Nevada.
In 2017 however, the Canada Revenue Agency (“CRA”) released a tax ruling concluding that, rather than being partnerships, the U.S. will treat LLLPs as corporations for Canadian income tax purposes.
Forming a partnership used to allow the US and Canadian tax systems to integrate. The income tax implications under both systems were generally the same. Now with the CRAs ruling, an LLLP could result in significant double taxation for Canadian investors who hold these US investments.
The classification of these entities as corporations for Canadian purposes means that they may be subject to Canada’s foreign affiliate taxation regime. It also means partners may have to file a Form T1134, annually.
The CRA has stated that it will treat existing LLPs or LLLPs as a partnership for all years prior to 2018, provided they meet following certain conditions.
Summary
In summary, if an LLLP truly interests you, make sure to choose one of the States where an LLLP exists. Then make sure and use a shell company as your general partner (just to be safe).
At KKOS lawyers, we charge the same mount for an LLLP, LP, or LLC. Want to learn more about which business entity is right for you? Book a demo today.
FAQs
What Does LLLP Stand For?
LLLP Stands for limited liability limited partnerships. It’s a newer type of tax entity, considered to be a form of LLP.
What are the Four Types of Partnership?
The four types of partnership are:
- General partnership
- Limited partnership
- Limited liability partnership
- Limited liability limited partnership
Is LLLP the Same as LLP?
The LLLP is not the same as an LLP. They offer similar types of protection, but an LLP does not distinguish between limited partners and general partners. In an LLLP there are both limited partners and general partners.
LLLP vs LLC: Which is Better?
LLCs are almost always a better option than LLLPs. In an LLLP, the business must determine who will be the general partner, who will be held personally liable for the actions of the business. An LLC does not require a general partner.
Who Owns an LLLP?
In an LLLP, a business is owned by both general and limited partners.
