Limited Partner

What Is a Limited Partner?

A limited partner is a part-owner of a company whose liability for the firm's debts cannot exceed the amount that an individual invested in the company. Limited partners are often called silent partners.

A limited partner invests money in exchange for shares in the partnership but has restricted voting power on company business and no day-to-day involvement in the business.

A limited partner may become personally liable only if they are proved to have assumed an active role in the business.

How a Limited Partner Works

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 IRS thus 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.

Liability for General and Limited Partners

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 may 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.

Tax Treatment for Limited Partners

Limited partnerships (LPs), like general partnerships, are pass-through or flow-through entities. That means that all partners are responsible for taxes on their share of the partnership income, rather than the partnership itself.

However, 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 Taxpayer Relief Act of 1986 allows limited partners to offset reported losses from passive income.

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 a person invested in the business.
  • A limited partnership by definition has at least one general partner and one limited partner.
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