Limited Partner: What It Is, Laws, Role, and Tax Treatment (2024)

FAQs

Limited Partner: What It Is, Laws, Role, and Tax Treatment? ›

LPs are pass-through entities for all partners, meaning the entity files a Form 1065. The partners receive Schedule K-1 forms to report their portion of the income or loss on their own personal tax returns. 7 Limited partners don't have to pay self-employment taxes, as they are not active members of the business.

What Is a Limited Partner? A limited partner invests money in exchange for shares in a partnership but has restricted voting power on company business and no day-to-day involvement in the business. A limited partner's liability for the firm's debts cannot exceed the amount that they have invested in the company.

A limited partner has no right to manage the business or to act as its agent, but he does have the right to vote on several important matters, such as admitting new partners. If a limited partner does manage the business, he may incur unlimited liability for partnership obligations.

Under the law, a partnership may only designate a general partner as its tax matters partner.

The primary duty of a limited partner is to provide capital contributions and shoulder company liability. Capital contributions may come in the form of cash, material assets, or services. In addition, there is a general duty of loyalty towards the company.

How are limited partnerships taxed? Limited partnerships (LPs) allow for pass-through taxation, as the LP's income is not taxed at the entity level, but a tax return for the partnership must be completed. Any income or loss of the LP as shown on this return is passed-through to the partners' individual tax returns.

Throughout the year, the business can make periodic distributions (partner draws) to compensate you as a partner so you can get paid for your investment. The business maintains a capital account for each partner. As a distribution (partner draw) is made, the partner's equity is reduced.

The structure of a limited partnership also comes with some downsides. They can be more difficult to transfer ownership of than a business such as an LLC, and there is less flexibility for changing management roles within the business.

Limited partners can offset their tax liability with certain losses, but not those that a general partner can deduct. Limited partnerships face different tax rules than general partners, who must claim the income earned from their share of the partnership on their tax returns.

The other partners (limited partners) have limited liability, meaning their personal assets typically cannot be used to satisfy business debts and liabilities. The amount of their liability is limited to their investment in the LP. Limited partners are not involved in management.

Why would a partner chose to be a limited partner? ›

If you want to start a business but don't have the money to do so, you can propose forming an LP. You, as the general partner, will take on all the liability risk and take care of business operations while the limited partners can sit back and collect their share of the profits. Limited partners have limited liability.

Because the management fee of each LTP is an ordinary and necessary expense paid or incurred in carrying on the trade or business of the LTP, the management fee is deductible under § 162.

Limited partners don't pay self-employment tax on their distributive share of partnership income, but do pay self-employment tax on guaranteed payments.

A limited partnership is formed by two or more entities and must have at least one limited partner and one general partner. Limited partners are only liable for the partnership's debts equal to their investment in the partnership.

A limited partnership has both general partners and limited partners. General partners bring their business expertise to the table and get 100% control over everyday management. In return, they are also fully liable for business debts and obligations.

Under this duty, partners must act with honesty and show good faith and fairness to each other in their partnership interactions. This continuing duty arises starting with the formation of the partnership.

Non-managing limited partners typically do not owe fiduciary duties to the limited partnership. However, limited partners who participate in directing or operating a limited partnership could end up treated as general partners by a court with the associated fiduciary duties.

In an LLP, management duties must be equally divided. In terms of liability, LLCs protect members from personal liability for debts or claims on the business. With an LLP, a partner is not liable for another partner's mistakes.

The main advantage for limited partners is that their personal liability for business debts is limited. A limited partner can only be held personally responsible up to the amount he or she invested. Limited partners enjoy a protected investment, knowing they cannot lose more money than they've contributed.