What is a 'Limited Partner'

A limited partner is a partner in a partnership whose liability is limited to the extent of the partner's share of ownership. Because he is not a material participant, The Internal Revenue Service (IRS) treats the income that a limited partner realizes from his partnership as passive income that he can offset with passive losses. A limited partner who participates in a partnership for more than 500 hours in a year may be considered a general partner.

BREAKING DOWN 'Limited Partner'

A limited partnership (LP) has at least one general partner and at least one limited partner. Some states let a limited partner vote on issues affecting the basic structure of the partnership, such as removing general partners, terminating the partnership, amending the partnership agreement or selling most or all of the company’s assets.

Liability for General Partners

A general partner typically receives payment for controlling the company’s daily operations and making legally binding decisions. A general partner is personally liable for business debts and legal proceedings. For example, if one general partner cannot pay a creditor’s debt, the creditor may collect from another general partner.

Liability for Limited Partners

A limited partner contributes financially to the business in exchange for a portion of the partnership’s profits. A limited partner cannot incur obligations on behalf of the partnership or participate in daily operations or management. For example, a limited partner may invest $100,000 in a real estate partnership but not have a say in business decisions.

Because he gives up management control, a limited partner cannot be forced to pay off business debts with personal assets. For example, if an LP owns a truck that accidentally injures someone, the damaged party may go after the general partner’s personal assets and the limited partner's investment in the business. Therefore, a limited partner may lose his financial investment in the company.

A limited partner may become personally liable if taking an active role in the business. If a creditor can prove the limited partner took action leading the creditor to believe the limited partner is a general partner, the partner may be held personally and fully liable for the creditor’s claims.

Tax Treatment for Limited Partners

Limited partners have different income tax rules. Although the IRS treats LPs like general partnerships and all partners individually report and pay taxes on their share of the profits annually, limited partners do not pay self-employment taxes. Because they are not active in the business, the IRS does not consider limited partners’ shares of partnership income to be earned income.

RELATED TERMS
  1. General Partner

    Owners of a partnership who have unlimited liability. A general ...
  2. Limited Partnership - LP

    Two or more partners united to conduct a business jointly, and ...
  3. Schedule K-1

    A tax document used to report the incomes, losses and dividends ...
  4. Partnership

    A business organization in which two or more individuals manage ...
  5. Active Partner

    An invested person who is involved in the daily operations of ...
  6. General Partnership

    A arrangement by which partners conducting a business jointly ...
Related Articles
  1. Small Business

    MLPs and Limited Partnerships: How They Differ

    Limited partnerships and master limited partnerships have one difference that makes all the difference.
  2. Taxes

    What's the Purpose of IRS Form 1065?

    Business partners need the information on this form to complete their own tax returns. Here are the details.
  3. Small Business

    What is a Partnership?

    A partnership is an organization where two or more owners operate a business.
  4. Investing

    What is Carried Interest?

    Carried interest is the percentage of a private equity or a hedge fund’s profits that its general partners receive as compensation.
  5. Insights

    Limited Liability Partnership (LLP): The Basics

    LLPs are a flexible legal and tax entity that allows partners to benefit from economies of scale by working together while also reducing their liability for the actions of other partners.
  6. Small Business

    How To Create A Business Succession Plan

    Make sure the business you built continues to thrive long after you've left the helm.
  7. Managing Wealth

    Protect Your Personal Assets

    A family limited partnership (FLP) can go a long way toward securing your family's property.
  8. Financial Advisor

    Partners Group: Investment Manager Highlight (PGHN)

    Get an inside look at some of the key executives and the investment approach of the global private equity investment firm Partners Group.
  9. Personal Finance

    Teaching Your Partner About Household Finances

    This is just one more way to take care of one of the most important people in your life.
  10. Personal Finance

    Financial Infidelity: Are YOU A Cheater?

    These sneaky financial moves could erode your finances - and your relationship.
RELATED FAQS
  1. What's the difference between limited liability partnership and general partnership?

    Learn the differences between general partnerships and limited liability partnerships; each type has unique traits, benefits ... Read Answer >>
  2. What is the difference between a silent partner and a general partner?

    Understand the difference between a person designated as a silent partner and a general partner under the partnership business ... Read Answer >>
  3. Which terms should be included in a partnership agreement?

    Understand what specific terms should be included in a business partnership agreement and how each affects the partners in ... Read Answer >>
  4. Can I buy insurance to reduce unlimited liability in a partnership?

    Find out why it is important to safeguard your general partnership in the even that one member becomes disabled, dismembered ... Read Answer >>
Hot Definitions
  1. Federal Direct Loan Program

    A program that provides low-interest loans to postsecondary students and their parents. The William D. Ford Federal Direct ...
  2. Cash Flow

    The net amount of cash and cash-equivalents moving into and out of a business. Positive cash flow indicates that a company's ...
  3. PLUS Loan

    A low-cost student loan offered to parents of students currently enrolled in post-secondary education. With a PLUS Loan, ...
  4. Graduate Record Examination - GRE

    A standardized exam used to measure one's aptitude for abstract thinking in the areas of analytical writing, mathematics ...
  5. Graduate Management Admission Test - GMAT

    A standardized test intended to measure a test taker's aptitude in mathematics and the English language. The GMAT is most ...
  6. Magna Cum Laude

    An academic level of distinction used by educational institutions to signify an academic degree which was received "with ...
Trading Center