The following guest article on Types of Business Entities in Texas was written by James
J. Burnett of Brownhill, Burnett & Associates, P.C. You can visit his web site at
http:\\www.jamesburnett.com.
Types of Business Entities in Texas
NOTE: This article discusses business law matters of current note in the State of
Texas according to Texas law. The author is not licensed to practice law in states other than
Texas, and the following should not be taken as statements of what the law is outside that
state.
A limited partnership is sort of a hybrid of a general partnership and a corporation. It provides protection for its limited partners from debts and claims of the business entity, but it allows the partners to pass profits and losses directly through the entity to them. It is similar to, but slightly different from, a general partnership in that there are two different kinds of partners. On this page, the term "partnership" means a limited partnership.
To form a limited partnership, the partners must enter into a written or an oral partnership agreement. They must also file a certificate of limited partnership with the Secretary of State of Texas. There is a filing fee for the certificate of limited partnership. Although an oral partnership agreement will work to form a limited partnership, one should be aware that it is very easy, inadvertently, to turn what one thought was a limited partnership into a general partnership. For that reason alone, it is probably a better idea to have a written partnership agreement defining the general and limited partners and their respective rights and duties. Although a partnership may have a perpetual term, typically the partnership agreement specifies a limited term for its existence.
A limited partnership must use the term, "Limited," "Limited Partnership," "Ltd.," or "L.P." in its name.
A partnership is not its own "person" under the law. It is merely a vehicle for its owners to use to accomplish their business purposes. This means that all profits and losses will be passed directly to the owners, either in equal proportions (if there is no agreement providing for different ownership interests) or in proportion to their respective ownership interests (if there is such an agreement). Also, the general partners have joint and several liability for the partnership's debts and for claims made against it. The limited partners usually may have individual liability for partnership debts and claims against it only to the extent of their ownership interests. However, if a limited partner takes a role in the management and operation of the partnership, he or she may be deemed to be a general partner with a general partner's joint and several liability.
The owners of a limited partnership are its general and limited partners. A partnership must have at least one general partner, at least one limited partner, and at least two different partners. In other words, the same person or entity cannot be both the general and the limited partner. The general partners are responsible for the day-to-day operation and management of the partnership, while the limited partners have much more restricted roles in its management. There are no restrictions on the number or type of partners the limited partnership may have. It can be owned by any number of individuals or business entities. There may be different classes of ownership interests in the same partnership. Partners may transfer their interests, but there is fully substitution of the transferee only if the partnership agreement provides for substitution, and there may be tax issues that arise from a freely transferable interest.
All partners must make a contribution to purchase their interest in the partnership. The contribution must be cash, property, services rendered, or a promissory note or other obligation. General partners may participate in the partnership's management, but the participation of limited partners is restricted.
The withdrawal, death, or retirement of a general partner triggers an "event of withdrawal," which may or may not lead to a winding up (that is, a closing down) of the partnership. The partnership's regulations may provide that a general partner's withdrawal, death, or retirement does not trigger partnership dissolution, but this may raise a tax issue. The death, withdrawal, or retirement of a limited partner does not trigger an "event of withdrawal."
The general partners' interests are not subject to the provisions of the Securities Act of 1933. The limited partners' interests are "securities" under the Act, but may be exempt from the provisions of the Act if the partnership is not publicly traded. If you have any questions about how the Securities Act affects partnership interests, you should consult with an attorney experienced in securities law.
Because profits and losses pass through the partnership to its owners, income is taxed at the partners' level. Special allocations of tax items are permitted if the entity is a partnership for tax purposes. Contributions on the formation of the partnership are not taxable unless there is a disguised sale or the partnership is relieved from debts. Partners may deduct their shares of partnership losses subject to their basis limitations, but the partnership debt is included in calculating the basis. The IRS's "at risk" and "passive activity" limitations apply to a partnership. Distributions are not taxable to the extent of a partner's tax basis in the partnership interest. earnings and profits. The liquidation of a partnership is not taxable to a partner to the extent of the partner's tax basis in the partnership interest. Partnerships are not subject to the Texas franchise tax.
Many states have mechanisms for a foreign limited partnership to qualify to do business there. If you plan to have your limited partnership do business outside the State of Texas, you should speak with an attorney in that state who is experienced with its laws and regulations concerning foreign partnerships.
If you decide to form a limited partnership, you should stay alert to these important points:
1. Do your paperwork. While literally nothing is required to form a general partnership, you must file a certificate of limited partnership, and you must have a (preferably written) partnership agreement. Also, there must be some form of partnership agreement defining everyone's roles, rights, and duties. An oral agreement is only as good as the audience's memory. A written agreement is probably a better idea.
2. Keep your roles straight. The difference between a general and a limited partner is an important one, and it is very easy for a limited partner to lose his protection from personal liability by doing things that make him a general partner. The bigger the role a partner plays in managing the partnership, the more likely that partner is to be considered a general partner.
3. Remember that a general partner has no shield from personal liability; he is jointly and severally liable for the debts the partnership incurs, and for any claims that are made against it.
To look at the other kinds of business entities that are available, click on one the following: