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A limited partner has at least one general partner and at least one limited partner. For the general partner, the partnership operates essentially like a general partnership – namely, that he or she is personally liable for all business debts.
The Role of the Limited Partner
Limited partners differ from general partners in three key ways:
- Limited partners do not play an active role in the day-to-day operations of the business. Limited partners invest in the partnership and may be involved in larger partnership issues (e.g., bringing on a new partner), but are not involved in everyday decisions.
- Limited partners are not personally liable for business debts. A limited partner is not personally liable for business debts. He or she stands to lose only the amount invested in the business.
- The taxes for limited partners are different from general partners. Overall, the tax consequences of the limited partnership are similar to that of the general partnership. Limited partners, however, do not typically pay self-employment taxes on their partnership earnings as they were not actively involved in the business.
“An Active Role in the Business”
It is important that the limited partner not exceed the passive role allowed by the limited partnership structure. Doing so may negate their liability protection and cause them to be personally liable for business debts similar to general partners. Check with your state of operation as some have specific rules regarding what constitutes an active role in the business.
Tax Consequences
While the partnership entity itself does not pay taxes, it does have an annual filing requirement: a Form 1065 due April 15th. This Form reports the partnership’s income and expense items to the federal government. The partnership then issues Schedules K-1 to each partner reporting their respective share of these income and expense items. Each partner reports items from the Schedule K-1 on his or her personal tax return.
