A limited partnership must have
at least one general partner and at least one limited partner. By
definition, general partners bear the entire economic risk of loss from
recourse partnership liabilities. A limited partner generally has no
obligation to contribute additional capital to the partnership to cover
liabilities, and therefore the risk of loss is limited to the original
capital contribution. Under partnership law, a partner has economic risk
of loss if that partner is obligated to pay creditors for any outstanding
amounts due in the event the partnership is liquidated.
Recourse Liabilities: A partnership
liability is a recourse liability to the extent that any partner has an
economic risk of loss from that liability.
Nonrecourse Liabilities: A
partnership liability is nonrecourse if no partner (either general or
limited) has an economic risk of loss for that liability.
At-Risk Basis: A partner may not
deduct partnership losses in excess of the partner’s at-risk basis in
the partnership. To the extent a partner is personally liable for his/her
share of partnership debt, the partner’s at-risk basis includes
partnership liabilities. However, at-risk basis will not increase by
amounts that are limited because of the partner’s status as a limited
partner, or because the liability is nonrecourse. Exception: A
partner’s at-risk basis may be increased by the partner’s share of
"qualified nonrecourse financing."
LLC Liabilities: Liabilities are
allocated differently for a limited partnership than for an LLC. Under the
general basis rules, a limited partnership allocates all of the recourse
liabilities to the general partners and none to the limited partners. An
LLC has no one member who is liable for the recourse liabilities. Thus,
under the general partnership allocation rules of Section 752, the
liabilities are allocated to all of the members in an LLC. However, under
the at-risk rules of Section 465, liabilities allocated to LLC members
will not increase the at-risk basis if the member is not held liable for
the debt. Thus, since no LLC member is ultimately liable for repayment of
the LLC liabilities; the liabilities of an LLC are nonrecourse liabilities
and do not increase the at-risk basis of the members. The at-risk rules
apply for purposes of determining whether there is sufficient basis to
deduct losses.
Liabilities Considered Recourse: The
following exceptions treat LLC debt as recourse liabilities.
1) A liability to the extent a member has
guaranteed the debt, or pledged property as security for it,
2) In states where liabilities retain their
recourse status in a partnership to LLC conversion,
3) A member makes a direct loan to the LLC,
and
4) Liabilities where a separate state law
obligation of a member exists.
Other Comparisons To LLCs
• A limited partnership must have at
least one general partner that has unlimited liability for the debts and
obligations of the partnership. An LLC has no equivalent member.
• An LLC is not subject to the same IRS
minimal capitalization requirements that apply to a corporate general
partner of a limited partnership. [Reg. §301.7701-2(d)]
• In most states, limited partners
generally cannot participate in management in order to obtain limited
liability status. LLC members with limited liability status are allowed to
participate in management.
Publicly Traded Partnerships (PTPs): IRC
§7704
Publicly Traded Partnerships, also called
Master Limited Partnerships, are partnerships with shares either traded on
an established market or tradable on a secondary market. PTPs are
generally treated as corporations for income tax purposes. Therefore, a
PTP is subject to double taxation; earnings are taxed first at the entity
level, with the remainder treated as taxable dividends when distributed to
the partner.
Two exceptions to corporate tax treatment:
1) A PTP that derives 90% or more of its
gross income from "qualifying" sources is not treated as a
corporation.
Qualifying income includes:
– Interest.
– Dividends.
– Real estate rents.
– Gains from disposition of real estate.
– Income or gains from mineral or natural resource operations.
– Gains from disposition of capital assets or property held for the
production of passive income.
2) "Electing 1987
Partnership": The law that began the taxing of PTPs as
corporations was enacted in 1987. However, a PTP that had shares traded
before 12/18/87 was generally exempt from the law under a
"grandfather exclusion." The grandfather exclusion had a
duration of ten years, and was set to expire for tax years beginning after
12/31/97. The Taxpayer Relief Act of 1997 extended the exclusion, allowing
"electing 1987 partnerships" to continue partnership status. Note:
This exception is only available to partnerships that qualified
under the 1987 grandfather exclusion.
To maintain status as an "electing
1987 partnership," the partnership must pay an annual tax of 3.5% of
its gross income from business activities. The 3.5% tax applies at the
partnership level and is subject to corporate estimated tax rules. See IRC
§7704 for more information about "electing 1987 partnerships."
When a PTP is not treated as a corporation
for income tax purposes, the investors must apply passive loss limitation
rules separately to each partnership. Losses can be applied only against
future gains from that specific partnership, not against other PTPs or
other passive activities. Suspended losses not offset by future gains are
deductible only when the partner completely disposes of the partnership
interest in a fully taxable disposition. Net passive income from a PTP
will be treated as investment income under IRC §163(d) for investment
interest expense limitation purposes. [IRS Notice 88-75]
