Limited Partnerships
A limited partnership (LP) is a business entity with at least one general partner and one or more limited partners. Its primary purpose is pass-through tax treatment - income, gains, losses, and deductions flow directly to partners' personal tax returns with no entity-level taxation.
Structure: General Partner vs Limited Partner
Every limited partnership has two types of partners with fundamentally different roles and liability.
| Role | Liability | Management | Taxation |
|---|---|---|---|
| General Partner (GP) | Unlimited personal liability | Full management authority; makes all business decisions | Pass-through via K-1 |
| Limited Partner (LP) | Limited to amount invested | No management role; passive investor only | Pass-through via K-1 |
General Partner (GP):
- Manages day-to-day operations and makes all business decisions
- Has unlimited personal liability for all partnership debts and obligations
- Owes a fiduciary duty to limited partners
- Can bind the partnership in contracts and legal matters
Limited Partner (LP):
- Provides capital as a passive investor only
- Liability is capped at the amount invested (plus any recourse debt)
- Losses can generally only offset passive income (Internal Revenue Service (IRS) passive activity rules)
- Has voting rights similar to common stockholders (e.g., vote to remove GP, dissolve partnership)
- Must sign a subscription agreement establishing suitability and investment commitment
Exam Tip: Gotchas
- GP has unlimited liability; LP has limited liability. This is the core distinction.
- A limited partner who participates in management decisions loses the liability shield and may be treated as a general partner with unlimited liability. This is the most-tested LP concept.
Pass-Through Taxation
The partnership entity does NOT pay income tax. All income, losses, deductions, and credits flow through to investors via Schedule K-1 (Form 1065), reported on each investor's personal tax return.
- Core advantage: Avoids double taxation that hits C corporations (no entity-level taxation)
- Income and losses flow through to each partner's personal tax return
Exam Tip: Gotchas
- Partners are taxed on their share of partnership income, not on distributions actually received. A partner may owe tax even if no cash was distributed.
Suitability
Suitability considerations:
- Suitable only for investors who can bear economic risk and tolerate illiquidity
- No active secondary market for LP interests
- Holding periods are typically long (often 7-12+ years)
- Investors should not need the capital for the life of the program
- Generally offered through private placements (Regulation D) to accredited investors
Exam Tip: Gotchas
- A client near retirement is almost never a suitable LP candidate. Illiquidity and long investment horizon are disqualifying regardless of financial strength.