Quick Answer
A limited partnership pairs a general partner, who runs the business and carries unlimited personal liability, with limited partners, who invest passively and are generally liable only up to what they invested. Income, gains, losses, and deductions pass through directly to each partner's tax return on a Schedule K-1, with no entity-level tax. LP interests are illiquid and typically suit only accredited, long-horizon investors.
The liability split and the passive-versus-active line are where most exam traps live: a limited partner who steps into management can lose the very shield that makes the role "limited."
How Do General Partners and Limited Partners Differ?
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) | Generally 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 generally 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 exercises control over management decisions risks the liability shield and may be treated as a general partner with unlimited liability. The result depends on the governing partnership law and the conduct; it is not an automatic universal reclassification. This is the most-tested LP concept.
How Are Limited Partnerships Taxed?
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.
Who Are Limited Partnerships Suitable For?
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), since there is no ready way to exit before the program winds down
- 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.
What Should You Check on Exam Day?
- Does the stem describe a limited partner taking an active management role? That can strip the liability shield the exam expects you to know is otherwise available.
- Is a partner's tax liability tied to distributions received, or to their share of income? It is share of income; cash need not change hands.
- Does the client profile show a short time horizon or near-term liquidity need? That disqualifies an LP regardless of net worth or risk tolerance.
- Is the offering described as public? LP interests are generally sold through Regulation D private placements to accredited investors, not public offerings.