As a new business owner, one of your most important decisions is determining what form of ownership will best meet your business needs. Selecting the best structure for your business should be a carefully planned process that is discussed with a qualified professional such as an enrolled agent, certified public accountant, or attorney who specializes in this area. In addition, as your business grows over time, you may want to evaluate if a new form of ownership should be used to achieve better results.
Limited partnerships are formed by two or more people, with at least one person acting as the general partner who has management authority and personal liability, and at least one person in the role of limited partner. All partners – both general and limited – must enter into limited partnership by either oral or written agreement. A formal written partnership agreement is advisable.
Limited partnerships are managed and controlled by one or more general partners; general partners have authority to bind the partnership. Limited partners normally do not participate in managing the business.
The general partners are liable for partnership obligations to the same extent as partners of general partnerships. Limited partners, however, are generally not liable for the partnership’s obligations; their only risk is their agreed capital contribution, or as otherwise provided in the partnership agreement. However, if limited partners participate in the management of the partnership business, they may lose their protected limited partner status and become liable to the same extent a general partner is.
Key Features of a Limited Partnership
- Flexible form of business and relatively easy to set up.
- Allows for more than one owner, unlike a sole proprietorship.
- Involves two or more people who agree to create a business and share in its profits and losses.
- The partners decide the structure of the entity, the allocation of profits and losses, and the timing and amount of distributions.
- The general partner is responsible for managing the business affairs.
- The limited partner typically provides only capital, such as cash, to the partnership.
- Each general partner assumes full personal liability for the debts and obligations of the partnership.
- The limited partner’s liability is normally limited to their investment in the partnership.
- It exists, subject to limitations imposed by California law, as long as the partners agree it will and as long as there are at least two partners, one of which is a general partner and one of which is a limited partner.
- Does not pay income tax.
- Pays an annual tax of $800 to California.
How to Form a Limited Partnership
To form limited partnerships, a Certificate of Limited Partnership (Form LP-1) must be filed with the California Secretary of State. A limited partnership formed in another state must register with the California Secretary of State by filing an Application to Register (Form LP-5) and attaching a completed form of valid certificate of good standing prior to conducting business in the state. The Secretary of State will assign a 12-digit filing number. Keep this filing number for your tax records. Contact the California Secretary of State at 916.657.5448 or go to sos.ca.gov for more information.
- A separate bank account should be established for the limited partnership.
- A formal written limited partnership agreement is advisable.
- The limited partnership should consider purchasing insurance to cover the risks of running the business. Consultation with a business attorney and an insurance specialist on the matter is advisable.
- Most cities and counties require a business license, various permits, and/or registration to do business within their city or county limits. If you are doing business in multiple cities or counties, you may be required to have multiple licenses. Contact the business licensing department of the city and/or county directly where your business will primarily be located for specific rules and regulations. The Governor’s CalGold online database at calgold.ca.gov, the Governor’s Office of Business and Economic Development (GO-Biz) at business.ca.gov, and the California Business Portal at businessportal.ca.gov all provide links and contact information to agencies that administer and issue business licenses, permits, and registration requirements from all levels of government.
- Contact your local Chamber of Commerce or call the statewide Chamber of Commerce at 800.331.8877 for information for your area and referrals to other agencies.
- If required, register a fictitious name, also referred to as “Doing Business As” or DBA. Refer to Appendix 1 in this booklet for more information.
Tax Return Filing Guidelines for a Limited Partnership
- Every one that is formed in California or registered with the California Secretary of State must file California Form 565, Partnership Return of Income even if it has no income from California sources.
- Every one that engages in a trade or business in California or earns income from California sources must file an informational return, Form 565.
- Generally, the due date of the Form 565 is the 15th day of the 3rd month after the close of the partnership’s taxable year.
- A limited partnership must pay an annual tax of $800 to California.
- Items of income, deductions, and credits flow through each partner’s limited partnership to its partners and are reported on each partner’s California Schedule K-1 (565), Partner’s Share of Income, Deductions, Credits, etc. even if they are not actually distributed.
- Provides each partner with a Schedule K-1 (565) that states the partner’s distributive share of the partnership’s items of income, deductions, and credits.
The limited partnership has no estimated tax requirements. However, California taxes are pay-as-you-go, so partners may have to make estimated tax payments for their own reporting purposes.
- Generally, both the limited and general partners’ estimated tax installment payments are due and payable on April 15, June 15, September 15 of the taxable year, and January 15 of the following taxable year.
- Individuals complete California Form 540-ES, Estimated Tax for Individuals to report their estimated taxes.
- Generally, you must make estimated tax payments if you expect to owe at least $500 ($250 if married/RDP filing separately) in tax for the current year (after subtracting withholding and credits) and you expect your withholding and credits to be less than the smaller of: 1). 90 percent of the tax shown on your current tax return; or 2). 100 percent of the tax shown on your prior year tax return including Alternative Minimum Tax (AMT).
- Each limited and general partner is responsible for paying taxes on their distributive share even if they are not actually distributed.
Limited partnerships must withhold 7 percent on distributions of California source income made to domestic nonresident partners when distributions to a particular partner exceed $1,500 for the calendar year.
If the limited partnership pays a nonresident independent contractor for services performed in California, generally, the limited partnership must withhold 7 percent on all payments that exceed $1,500 in a calendar year.
If the limited partnership is required to backup withhold for the Internal Revenue Service, it must also backup withhold for the Franchise Tax Board on California source income. Backup withholding applies to California residents and nonresidents who do not provide a taxpayer identification number or do not certify exemption from backup withholding when required.
For more information about limited partnership withholding, see FTB PUB 1017, Resident and Nonresident Withholding Guidelines.
How to End a Limited Partnership
- File California Form 565 for the last taxable year, check the box that indicates that it is a final return, and write “Final” on top of the return.
- File California Form 565 for all delinquent tax years.
- Pay all outstanding tax liabilities, penalties, and interest.
- Publish notice of its dissolution requesting persons with claims against it to present them (see California Corporations Code Section 15908.07).
- Dispose of known claims by following the procedures specified in California Corporations Code Section 15908.06.
- File a Certificate of Cancellation (Form LP-4/7) with the California Secretary of State.
- Notify all creditors, vendors, suppliers, clients, and employees of its intent to go out of business.
- Close out business checking accounts and credit cards.
- Cancel any licenses, permits, and fictitious business names.
- Consider publishing a statement in a local newspaper of general circulation near the principal place of business that the limited partnership is no longer in business.
- Refer to FTB PUB 1038, Guide to Dissolve, Surrender, or Cancel a California Business Entity for more information on how to cancel a limited partnership.
Liability of Partners
The Partners of a Limited Partnership are protected from Law suits in that their Limited Partnership interest cannot be taken by a creditor under a rule called the Charging Order. The Charging Order basically give a single remedy to a creditor of a Limited Partner, that is the ability of the creditor to receive the Benefits and Responsibilities of the Limited Partner. See our other Report on Liability Protection provided for by a Family Limited Partnerships.
The process of setting up a limited partnership may seem daunting… but, it doesn’t have to be.