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.