Incorporator The Journal of U.S. Formation
Start Free Quiz
Editorial 12 MIN READ

The limited partnership in mid-2020: a field report from a shuttered economy

Twenty months past our OZ-and-BBA rewrite, the LP still works the same way, except the Paycheck Protection Program draws a line through the partnership agreement and Opportunity Zone sponsors are counting days waiting for Treasury

The Editors
Staff, Incorporator.org
12 min read Updated
Contents 6 sections
  1. The statute, unchanged through the pandemic
  2. The Paycheck Protection Program draws a bright line
  3. Opportunity Zone funds are counting days
  4. Section 199A is settled law
  5. The form in June 2020
  6. Sources

he limited partnership is doing the same three jobs it did in October 2018, under dramatically different conditions. Opportunity Zone fund sponsors are sitting on capital whose 180-day investment clock ran out during a nationwide lockdown, waiting on Treasury to say whether the clock stops. Partnerships that tried to apply for a Paycheck Protection Program loan learned on April 14 that partners cannot file separately and that the partnership carries the whole application. Section 199A final regulations have been on the books since February 2019 and the qualified-business-income deduction is now a settled line item on partner K-1s. The statute is unchanged. The stress tests are new.

Our February 2017 piece walked the form from first principles and our October 2018 revisit reset it for Opportunity Zones, the BBA audit regime, and the freshly enacted § 199A. Twenty months on, the form has taken a pandemic on the chin and is still the vehicle of record for pooled private capital.

The statute, unchanged through the pandemic

Delaware's Revised Uniform Limited Partnership Act remains at 6 Del. C. Chapter 17. Formation under § 17-201 is still the two-page job it was in 2017 and 2018: a Certificate of Limited Partnership naming the partnership, its Delaware registered office and registered agent, and the name and business address of each general partner. The partnership agreement is private and is not filed. The Division of Corporations charges $200 for the Certificate of Limited Partnership and collects a $300 annual tax under § 17-1109 on every Delaware LP, domestic or foreign-registered, due June 1 with the same $200 late penalty and 1.5 percent monthly interest that have been on the books for years. Section 17-1109 also imposes a $75 per-series tax on each registered series of a domestic LP, which the 2019 statutory amendments added and which becomes operationally relevant this year for the small population of series LPs on the rolls.

Delaware's Division of Corporations ran through the March and April shutdown without closing its filing window; the filing office is part of the executive branch's essential operations in the governor's state-of-emergency orders, and the state's online-filing posture that we covered in our June 2019 benchmark held up under the pandemic load. Other states have had a rougher time, and if you are forming an LP this quarter in California, Illinois, or New York you are looking at filing queues that run longer than the paper you are holding.

The ULPA (2001) enactment count continues to drift upward at a handful of states per biennium. The Uniform Law Commission's current map shows the Act in force in roughly twenty-three jurisdictions, with a mix of 1976 and 1985 RULPA vintages in holdouts. For fund formation the Delaware pick remains overwhelming, and the § 17-303(b) safe harbor continues to be why.

The Paycheck Protection Program draws a bright line

The CARES Act established the Paycheck Protection Program on March 27, 2020, authorizing SBA 7(a) loans of up to $10 million forgivable to the extent used for covered payroll, rent, and utilities. The statute was passed in a week and the administering guidance arrived in a series of Interim Final Rules through April and May. One of those IFRs matters directly to the LP form.

The First Interim Final Rule, 85 Fed. Reg. 20811 (April 15, 2020, for the April 2 posting), and the "Additional Eligibility Criteria" Interim Final Rule at 85 Fed. Reg. 21747 (April 20, 2020, for the April 14 posting), together establish the rule that matters for a partnership. A partner in a partnership may not apply as a separate self-employed individual for a PPP loan on the basis of partner self-employment income. The self-employment income of general active partners, capped at $100,000 annualized per partner, is instead reported as a payroll cost on a single PPP loan application filed by the partnership. SBA's stated reason is operational: allowing partners and partnerships to apply separately would create coordination and allocation problems the program was not built to handle.

The distinction between limited partners and general partners inside this rule is doing real work. "Self-employment income of general active partners" is the operative phrase. A passive limited partner in a real estate LP is not producing self-employment income under IRC § 1402(a)(13) and has no line 14 on Schedule K-1 to report. Those partners contribute nothing to the partnership's PPP payroll-cost calculation, and their K-1 distributive share does not appear in the payroll-cost numerator. A general partner running the business, or a limited partner who is a manager-member-type participant whose income is actually self-employment income, does contribute. In an operating LP with two or three general partners doing the work and a pool of passive limited partners funding it, the PPP payroll cost is driven by the GP compensation, period.

The practical consequence for LPs formed for pooled investment (PE funds, VC funds, real estate syndications) is that the program is largely not accessible at the fund level. A buy-and-hold real estate fund does not have self-employment earnings in the § 1402 sense. Its general partner does, at the management-company level, which is a separate entity. Most fund complexes that pursued PPP did so through their management company, not their fund partnerships. For operating LPs, which are a much smaller share of the population, the April 14 IFR sets the mechanics and the $100,000 cap becomes the binding constraint for any GP earning above it.

Second-round PPP appropriations under the Paycheck Protection Program and Health Care Enhancement Act (Pub. L. 116-139, April 24, 2020) added $310 billion to the pot, and that money is moving as of the first week of June. The application window is set to close on June 30. Any LP that has not applied and intends to is looking at four weeks.

Opportunity Zone funds are counting days

Qualified Opportunity Funds under IRC § 1400Z-2(d)(1) continue to operate under the final regulations published December 19, 2019 at 84 Fed. Reg. 68722 (T.D. 9889). Those final regs closed out the two rounds of proposed rules (October 2018 and April 2019) and resolved most of the structuring questions we flagged in our October 2018 piece, including the treatment of qualified opportunity zone businesses, the working-capital safe harbor, and the interim-gains rules. By the end of 2019, OZ fund sponsors were operating with a complete rulebook and the LP form was firmly the vehicle of choice for the larger, institutionally sponsored funds.

Then March happened. The pandemic hit while hundreds of QOFs were inside their semiannual 90 percent asset test windows, their substantial-improvement 30-month clocks, and their investors' 180-day reinvestment periods. The statute's deadline machinery does not bend for force majeure.

Treasury and the IRS have issued one round of deadline relief so far. Notice 2020-23, 2020-18 I.R.B. 742 (April 9, 2020), treats taxpayers whose 180-day OZ investment window ended between April 1 and July 15 as having until July 15, 2020 to make the investment. The notice operates through the general deadline-extension machinery of IRC § 7508A, pulling OZ investment deadlines into the broader basket of tax-return and filing deadlines that were postponed by the pandemic.

What Notice 2020-23 does not do is give the QOFs themselves relief on the 90 percent asset test, on the 30-month substantial improvement period, or on the 31-month working-capital safe harbor. A QOF whose first six-month testing date landed in April or May is, under the letter of the statute, expected to have deployed 90 percent of its assets into qualified opportunity zone property at that date, pandemic or no pandemic. The sponsor community has been asking Treasury for a tolling regime since late March. Comment letters from the major OZ trade groups and fund sponsor law firms have been on file at Treasury since April, and the understanding inside the practice is that a more comprehensive notice is in drafting. Whether it arrives in June or July, and whether it provides automatic reasonable-cause treatment for missed 90-percent test dates and a tolling period for substantial improvement, is the open question that determines whether a large fraction of 2019-vintage QOFs have to take corrective actions or pay penalties.

If you are drafting an LP agreement for a QOF this week, you are papering around the uncertainty in two places. The working-capital safe harbor language gets an expansion to cover federally declared disaster areas, which under Treas. Reg. § 1.1400Z2(d)-1(d)(3)(v)(D) already extends the 31-month period for QOZBs in disaster zones. (Every county in the United States is in a federally declared disaster area as of the March 13 major disaster declaration, which is doing more work for this provision than anyone anticipated when it was drafted.) The 90-percent test language picks up a reasonable-cause carve-out tied to "any pending Treasury relief under IRC § 7508A or otherwise" to give the sponsor room to point at whatever notice lands next. This is belt-and-suspenders drafting against a regulatory clock that the industry is not running.

Section 199A is settled law

T.D. 9847, the final regulations under IRC § 199A, was published at 84 Fed. Reg. 2952 on February 8, 2019, superseding the proposed regs (REG-107892-18) that we covered in our SSTB piece. A correcting amendment followed at 84 Fed. Reg. 15954 on April 17, 2019. A second set of final regs under T.D. 9899 published January 2020 addressed cooperatives and some outstanding questions left by T.D. 9847. For the LP form in mid-2020, the operative picture is: Treas. Reg. §§ 1.199A-1 through 1.199A-6 are in force, apply to taxable years ending after February 8, 2019, and govern the computation of the 20 percent qualified-business-income deduction at the partner level.

Treas. Reg. § 1.199A-6(b) confirms what the partnership bar was hoping the final regs would confirm: partnerships report each partner's distributive share of QBI, W-2 wages, and unadjusted basis immediately after acquisition (UBIA) on the Schedule K-1, and the partner does the 199A computation on its own Form 1040. For an LP, this means the sponsor's Form 1065 does the allocation under IRC § 704(b) and issues K-1s; each limited partner plugs its own distributive share into the 199A mechanics at its own taxable-income level. The $157,500 single and $315,000 joint thresholds from 2018 are indexed for inflation and sit at $163,300 and $326,600 for 2020.

The specified service trade or business analysis is where the final regs did the most work. Treas. Reg. § 1.199A-5(b)(2) retained the narrow readings of the proposed regs (real estate brokerage is not "brokerage services"; property management is not financial services) and codified them in enforceable form. For a real estate LP holding rental property that rises to a § 162 trade or business under the safe harbor in Rev. Proc. 2019-38 (the 250-hour rental real estate safe harbor), the 199A deduction flows through to limited partners on their distributive share of rental trade-or-business income. For a PE or VC fund LP, the fund's investment-income character keeps most of its activity out of § 199A entirely, which was already the expectation in October 2018 and which the final regs did not change.

The one practical issue in 2020 is the interaction between § 199A and the BBA audit regime. An imputed underpayment assessed at the partnership level under IRC § 6225 does not, by default, reflect any partner-level § 199A deduction the reviewed-year partners would have taken. The push-out election under § 6226 solves this by pushing the adjustment out to the reviewed-year partners, who each re-run their § 199A computation with the adjusted numbers. LP agreements that did not already mandate a push-out election are, as a rule, amending to add one this year; losing the § 199A deduction on an audit adjustment is a cost the current partners are unwilling to eat on behalf of reviewed-year partners they do not know.

The form in June 2020

The LP's 2020 profile is roughly what the 2018 profile was, with a pandemic overlay. Real estate syndications and private investment funds remain the two natural habitats. Opportunity Zone funds continue to drive LP formation volume at the institutional end, and the question of whether Treasury tolls the 90 percent asset test will shape the viability of the 2019-vintage QOFs regardless of what the LP agreement says. The BBA audit regime is now two and a half years old and every LP agreement drafted in 2020 paper is naming a partnership representative and building out the consent machinery the Code does not provide. Section 199A is finalized and priced in. PPP is a management-company story, not a fund-LP story, and for operating LPs it is a $100,000-per-active-partner payroll-cost ceiling that founders who have never heard of IRC § 1402 are suddenly learning to identify.

The form is not the right answer for a new operating business in 2020 any more than it was in 2017 or 2018. If you are forming an LP this quarter for a QOF, Delaware this week, name a capable partnership representative, paper the push-out election, and write a working-capital safe harbor that will survive whatever Treasury does next. If you are forming for anything other than real estate or pooled investment, the LLC does the same work without the GP's residual exposure, and the reason to reach for the LP is the reason to ask again whether you have the right vehicle.

Sources

Keep reading

More from the journal.