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. Limited partners are often called silent partners.
Key Takeaways
- A limited partner, also known as a silent partner, is an investor and not a day-to-day manager of the business.
- The limited partner’s liability cannot exceed the amount that they have invested in the business.
- A limited partnership (LP), by definition, has at least one general partner and one limited partner.
Understanding Limited Partners
A limited partnership (LP), by definition, has at least one general partner and at least one limited partner. The general partner or partners manage the business from day to day.
Although state laws vary, a limited partner doesn’t generally have the full voting power on the company business of a general partner. The Internal Revenue Service (IRS) considers the limited partner’s income from the business to be passive income. A limited partner who participates in a partnership for more than 500 hours in a year may be viewed as a general partner.
Some states allow limited partners to vote on issues affecting the basic structure or the continued existence of the partnership. Those issues include removing general partners, terminating the partnership, amending the partnership agreement, or selling most or all of the company’s assets. A limited partner may become personally liable only if they are proved to have assumed an active role in the business.
General Partner vs. Limited Partner
A general partner typically is compensated for controlling the company’s daily operations and making day-to-day decisions. As the business decision maker, the general partner can be held personally liable for any business debts.
A limited partner has purchased shares in the partnership as an investment but is not involved in its day-to-day business. Limited partners cannot incur obligations on behalf of the partnership, participate in daily operations, or manage the operation.
Because limited partners do not manage the business, they are not personally liable for the partnership’s debts. A creditor may sue for repayment of the partnership’s debt from the general partner’s personal assets.
A limited partner may become personally liable only if they are proved to have assumed an active role in the business, taking on the duties of a general partner. A limited partner’s loss from the company’s operations may not exceed the amount of the individual’s investment. Investors in private equity funds are called limited partners.
Tax Treatment for Limited Partners
Limited partnerships, like general partnerships, are pass-through or flow-through entities. This means that all partners are responsible for taxes on their share of the partnership income, rather than the partnership itself.
Limited partners do not pay self-employment taxes. Because they are not active in the business, the IRS does not consider limited partners’ income as earned income. The income received is passive income. The Tax Reform Act of 1986 allows limited partners to offset reported losses from passive income.
What Is the Role of a Limited Partner?
A limited partner is an investor who does not make decisions for either a company or assets in a partnership. Limited partners are also often referred to as silent partners.
What Are the Advantages of Being a Limited Partner?
Limited partners can invest while keeping their liability limited. Liability is limited to the amount that a limited partner has invested. The limited liability of a limited partner is ideal for an investor who wants to own a stake in a business without the risk of being exposed to unlimited liability.
How Are Limited Partners Taxed?
Because limited partners are investors who do not take an active role in the business, the IRS does not consider any income they receive from the limited partnership as earned income. Instead, it is viewed as passive income, which is not subject to self-employment taxes.
The Bottom Line
A limited partner, often called a silent partner, is an investor. Unlike general partners in a limited partnership, limited partners don’t make business decisions. Because limited partners are not active in the business, the IRS doesn’t view income from the partnership as earned income. That means limited partners aren’t subject to self-employment taxes.
Related Terms: general partner, limited partnership, passive income, investment, silent partner.
References
- Cornell Law School, Legal Information Institute. “Limited Partnership”.
- Internal Revenue Service. “Publication 925 (2022), Passive Activity and At-Risk Rules”.
- Cornell Law School, Legal Information Institute. “General Partner”.
- Cornell Law School, Legal Information Institute. “Limited Liability”.
