When to use an LLLP…
I have searched far and wide for a good reason to have an LLLP versus using another form of doing business and frankly, I can’t find one. I never recommend them.
Although, they have been adopted in now more than 20 states as a more unique asset protection tool, whoever conceived of them forgot to talk with an accountant and consider the tax ramifications. Any good CPA could explain why the typically Limited Liability Company (LLC) doesn’t already accomplish what they’re trying to achieve.
Bottom line, I think they are overkill and if someone is strongly recommending an LLLP, I in turn strongly urge you to get a second opinion and also talk with your CPA about any tax benefits or drawbacks.
GP, LP, LLP and LLLP – Why??
First, we have to understand how the LLLP plays with its brothers and sisters and fits into the family of partnerships.
General Partnership (GP)
The General Partnership (GP) is arguably the oldest form of doing business in the history of the world. Its inception dates back to when two farmers or sheepherders agreed to do business together to sell their product at the local market. A general partnership can be created with a contract or even a simple handshake or more recently with two emails agreeing to work together. Both partners are liable for everything. GP’s are absolutely terrible for asset protection and tax purposes without additional structuring.
Limited Partnership (LP)
Limited Partnerships (LP) are arguably one of the oldest forms of doing business, dating back to when two people agreed to pick fruit or vegetables and sell them at the market. The Limited Partner puts up the capital, the General Partner does all the work. The Limited Partner isn’t personally liable for someone slipping in front of the banana stand (that was for you Arrested Development fans). The worst that can happen would be they lose their investment of capital. The General Partner faces many problems, the first being, they are liable for everything in an LP… and I mean problems with an ‘s’. To protect the General Partner, we need to set up a separate entity. Not to mention, real estate investor’s 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) came onto the scene in Texas in 1992, and now over 40 states have some form of an LLP statute. They are pretty cool. There is no General Partner in an LLP. Hence, no one is liable for the operations of the LLP per se…and all of the limited partners aren’t personally liable for business debts. They are just liable for their actions if negligent and/or acting out of the scope of the purpose of the LLP. The only problem: they were created for lawyers, accountants, doctors, architects, and other professionals- surprise! The states get to decide which professionals get to use them and they are the ONLY ones that can employ the amazing benefits of the LLP. Sorry real estate investors.
Limited Liability Limited Partnership (LLLP)
So that’s when someone came up with the ‘brainiac’ idea of the Limited Liability Limited Partnership (LLLP), rather than use the now popular and well-established LLC that does the same thing with the ‘Manager’ of the Limited Liability Company. The LLLP was designed to completely eliminate the automatic personal liability of the general partner for partnership obligations and, under most statutes, 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”.
So why isn’t everyone rushing to set up their business as an LLLP? That’s where the smoke and mirrors come in.
The Basic Structure and Asset Protection of the LLLP
The LLLP is a relatively new form of doing business and frankly gets a little too much hype in my personal opinion. 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 protection and my client limits their risk significantly with established asset protection and tax law.
The Tax Benefits
There are none. In fact, I think 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 imperative to ‘register’ their entity in the State they are doing business in 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 answer: 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 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 wreaked 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 guess, I would think states that had a poor common law history of recognizing Limited Partnerships and their protection for Limited Partners, the legislatures may have wanted to take it upon themselves to implement a blatant and outright state statute to create ‘limited liability’ protection for it’s limited 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 used to rely on the LLLP strategy and were sold this structure for years…typically creating the LLLP in Delaware, Florida or Nevada. However, the party is over and there isn’t even an after party.
In 2017, the Canada Revenue Agency (“CRA”) released a tax ruling concluding that, rather than being partnerships, U.S. LLLPs will be treated as corporations for Canadian income tax purposes.
Previously partnerships allowed the US and Canadian tax systems to integrate well as 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 also means that they may be subject to Canada’s foreign affiliate taxation regime and that 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 the meet following certain conditions.
In summary, if you are truly interested in an LLLP, make sure to choose one of the States where an LLLP exists and make sure and use a shell company as your general partner (just to be safe). 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.
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Mark J. Kohler is a CPA, Attorney, co-host of the Radio Show “Refresh Your Wealth” and author of the new book “The Business Owner’s Guide to Financial Freedom- What Wall Street isn’t Telling You” and, “The Tax and Legal Playbook- Game Changing Solutions For Your Small Business Questions”. He is also a partner at the law firm Kyler Kohler Ostermiller & Sorensen, LLP and the accounting firm K&E CPAs, LLP.