Obtaining Limited Liability for the General Partner
of a Family Limited Partnership

Family limited partnerships are an important vehicle in estate planning to convey interests in valuable assets, such as real estate and marketable securities, to family members at reduced gift tax values and allow the transferor, typically a parent, to retain management control over the asset as the general partner. Typically, one or both parents organize the limited partnership, contribute the assets and receive back both general and limited partnership interests. They then make gifts of the limited partnership interests to children or trusts for children. As general partners, the parents retain managerial control over the assets. The disadvantage of the limited partnership is that the general partner has unlimited liability for the debts of the partnership as well as any claims, such as tort liabilities, of the partnership. The limited partners are not liable for the debts and claims of the partnership.

In 1993, the North Carolina Limited Liability Company Act (the "Act") was adopted. While limited liability companies ("LLCs") are taxed in the same manner as limited partnerships, they offer one distinct advantage: the owners, called "members," whether or not they participate in management, are not liable for the debts and claims against the LLC unless voluntarily assumed by the members. Following adoption of the Act, some family limited partnerships elected to convert to LLCs. However, such conversion can be somewhat expensive as Articles of Conversion and Articles of Organization must be prepared and filed with the Secretary of State and an Operating Agreement must be prepared for the LLC.

Effective January 1, 2002, the North Carolina Legislature has offered another alternative to the family limited partnership: registration of the partnership as a "limited liability limited partnership" ("LLLP"). While the name appears to be somewhat redundant, the effect of such a registration is that as to future debts and claims against the family limited partnership arising after registration, the general partner of the LLLP will not have personal liability. From a practical standpoint, this new distinction may or may not be beneficial to the general partner. If future creditors, such as mortgagees, will require that the general partner personally guarantee the debt, status as an LLLP will not shield the general partner. But for other future creditors, particularly tort claim creditors, the registration to become an LLLP will be beneficial.

To become an LLLP, the limited partnership files an application for registration with the North Carolina Secretary of State stating the name of the partnership, the address of its principal office and its fiscal year. The registration must be approved by the partners pursuant to the terms of the limited partnership agreement. Typically, all the partners, both general and limited, would have to consent to the change. The partnership agreement may also have to be modified to address provisions such as requiring that a general partner make future contributions to the partnership to fund its liabilities. The name of the partnership on the application filed with the Secretary of State must contain the words "limited liability limited partnership" or "LLLP."

Compared with a conversion of a limited partnership to an LLC, the registration to become an LLLP may be less expensive, depending upon the extent to which the limited partnership agreement has to be amended. However, careful consideration should be given to whether it is better for the final entity to be an LLLP or an LLC. The following are some factors to consider:

1. Management

An LLC may either be managed by all the members, or by a select group of members. An LLC may also be managed by outside third parties who are not members. As an estate planning vehicle, an LLC offers the advantage of allowing the parents to control management by being the managers during their lives but after they are gone, the children as successor members may elect for all the members to participate in management, thus making the LLC more flexible from a management standpoint.

An LLLP is typically managed by the general partner. While North Carolina law has recently been modified to allow limited partners to participate in management without exposing them to liability as a general partner, the usual format of the limited partnership agreement concentrates the managerial power in a general partner. Unlike an LLC, an LLLP typically is not managed by an outside third party. If the client would prefer to concentrate control of the entity in one or more general partners rather than allow all owners to participate, then the LLLP will be the preferred entity.

2. Perpetual Existence

LLCs are not required to liquidate at a date certain. Effective January 1. 2002, the Uniform Limited Partnership Act has been amended to allow limited partnerships to exist perpetually.

3. Effect of Conversion on Tax Basis

Care should be taken in planning a conversion to an LLC or a registration to become an LLLP on each partner’s share of the entity’s liabilities. Such liabilities affect the partner’s or member’s tax basis in the entity, and if the partner is no longer liable for a debt, or his share of debt declines, this could result in gain recognition by him for income tax purposes. While the registration to be an LLLP and conversion to an LLC does not affect the prior liabilities of the electing or converting partnerships, the partners should consult with their tax advisor to confirm there is no shift in allocation of liabilities.

4. Effect on Title to Real Estate

When a limited partnership converts to an LLC, the Secretary of State issues a certificate that the LLC must file with the Register of Deeds in each county in which it owns real estate. No new deed need be filed. In the case of the registration of a limited partnership to become an LLLP, the Secretary of State’s office has tentatively decided that a stamped copy of the LLLP registration should be recorded with the Register of Deeds in each county in which it owns real estate. While the LLLP is the same legal entity as the electing limited partnership and thus title does not transfer to a new legal entity, such a filing will avoid any questions as to title to real estate.

5. Tax Effect of Conversion of Limited Partnership to LLC and Registration of Limited Partnership as an LLLP

If the conversion of a limited partnership to an LLC does not change each partner’s share of profits, losses or capital and does not change the share of debt of each partner, generally no gain should be recognized for income tax purposes upon the conversion, although the partner should confirm this with their tax advisor. In the case of a registration of the limited partnership as an LLLP, the resulting entity does not change and unless there is a shift in share of partnership liability, no gain should be recognized. In either case, for income tax purposes the resulting entity is deemed to be the same one, and there is no need to obtain a new federal identification number.

6. Use of LLLP and LLC as a Gifting Entity

Where it is anticipated that gifts will be made of non-managerial interests in the resulting entity, both LLLPs and LLCs should provide approximately the same discount in valuation of such interest for gift tax purposes where they both have the same characteristics of perpetuity of existence and restrictions on transferability. However, because many factors affect the valuation of an interest for gift tax purposes, the transferring partner should consult with his tax advisor on this issue.

7. Ability to Have Single Owner

If there is a chance that the resulting entity will eventually be owned by one person, such as by a surviving spouse, the LLC is the preferred alternative. An LLC may be owned by a single member, but limited partnerships must have at least two partners. Thus, upon there being only one partner, the partnership will terminate, thereby exposing the remaining partner to the partnership’s liabilities.

8. Doing Business Outside North Carolina

If the resulting entity will conduct business or own real estate outside of North Carolina, the partners should confirm that the limited liability characteristics of the LLLP will be recognized in that foreign jurisdiction. As the concept of an LLLP is newer than that of an LLC, the partners may find that the LLC offers greater protection in other states.

This bulletin has been prepared jointly by the Estates, Trusts and Exempt Organizations Section, the Tax Section, and the Business Organizations Section of Poyner & Spruill, LLP. Contributing editors include: Craig Dalton, Bill Belcher, Pearl Doherty, Mark Edwards, Frank Meadows, Tom Norris, and Laura Urich. 

If you have any questions regarding this bulletin, please contact Craig Dalton at (919) 783-2943 or craigdalton@poynerspruill.com.