Limited partnerships are just one of several different types of partnerships. A limited partnership is a partnership with two kinds of partners, general partners, and limited partners. General partners manage the business, while limited partners (also called silent investors) only invest capital.
General partners are personally liable for the business, including any business debts, while limited partners are only at risk of losing their initial investment in the business and can’t be held personally liable for business debts.
Features of a Limited Partnership
Limited partnerships are different from other types of partnerships because there are different types of partners. This type of partnership recognizes the role of each partner and allows them to serve the partnership in their own ways.
The limited partner only invests capital in the partnership. Many businesses need capital to open their doors, and the limited partner can invest the capital without taking on the responsibility of managing the day-to-day operations of the company. Additionally, the limited partner’s income isn’t subject to self-employment tax, since they aren’t an employee of the partnership.
The general partner is responsible for making business decisions and running the business operations.
How is a Limited Partnership Different From Other Types of Partnerships?
Limited Partnership vs Limited Liability Companies
In a limited liability company (LLC), each member usually has limited liability. This means that they won’t be personally responsible if the company’s debts exceed its assets. However, in a limited partnership, only the limited members who don’t take an active part in managing the business have this same protection.
Limited Partnership vs General Partnership
Some partners in a limited partnership are investors only. They don’t carry the same personal risk as the general partners. However, in a general partnership, each member helps run the business and each member typically carries the same amount of risk.
Limited Partnership vs Limited Liability Partnership
Even though their names are similar, limited liability partnerships (LLPs) are much different than limited partnerships. In an LLP, each partner is protected from taking on personal liability for the actions of the other partners in the LLP. In that way, each partner only takes responsibility for his or her own actions.
Advantages of a Limited Partnership
Limited partnerships can provide a beneficial structure for businesses that have both general partners with the knowledge and skills to run the company, as well as investors who don’t wish to be involved in the day-to-day management of the business.
This structure allows companies to access funding. The investors can provide capital for the business and reap the rewards if it succeeds without accepting additional liability beyond the capital they invest. General partners can accept full responsibility for managing the business well, without having to look for additional capital or give up control of their business to the investors.
Disadvantages of a Limited Partnership
While there are advantages to forming a limited partnership in some situations, there are a few disadvantages as well.
One disadvantage is that limited partnerships are subject to certain regulatory compliance rules. Each state has its own rules about limited partnerships, so you’ll need to make sure you comply with your state’s laws. Most states require that you formally create your limited partnership, identify the general and limited partner(s), and have regular investor meetings for all members to review your company’s financial records.
Another disadvantage for the general partners is that they can be held personally liable for business debt. And on the flip side, a disadvantage for the limited partners is that they can not help make business decisions.
Managing Taxes in Limited Partnerships
Limited partnerships are pass-through entities. This means that they don’t pay taxes on the partnership level. Instead, income flows through the partnership and each partner claims their income (or loss) on his or her individual tax return. Limited partnerships file Form 1065 with the IRS each year and report members’ incomes on Form K-1.
Limited partners aren’t subject to self-employment tax, since they aren’t considered employees of the business. Their income is passive income and is still subject to state and federal income taxes. General partners, however, are subject to self-employment taxes since they are involved in daily business operations.
When are Limited Partnerships Useful?
Limited partnerships are useful for raising capital since limited partners can invest in a company and leave the management and liability to the general partner. There are certain types of businesses where limited partnerships are more common:
- Commercial real estate projects, where the general partner manages the contracts and the limited partners provide capital
- Real estate ventures, where limited partners provide investment capital for purchasing investment property
- Small businesses with high upfront costs, such as retail stores
- Private equity firms, where limited partners purchase a group of businesses and the general partner helps manage them to resell later for a profit
Family limited partnerships, another type of limited partnership, are another specific situation where a limited partnership can be useful.
Final thoughts on limited partnerships
Deciding how to set up your business is a significant decision. And while limited partnerships have some clear benefits, they aren’t always the best choice. Another type of partnership may be a better choice depending on your business goals.