Definition: A business organization that allows limited partners to enjoy limited personal liability while general partners have unlimited personal liability .
A limited partnership is similar to a general partnership except that it has two classes of partners. The general partner(s) have full management and control of the partnership business but also accept full personal responsibility for partnership liabilities. Limited partners have no personal liability beyond their investment in the partnership interest. Limited partners cannot participate in the general management and daily operations of the partnership business without being considered general partners in the eyes of the law.
The general partner can be either an individual or a corporation. One of the more common limited partnership situations involves a silent partner, where one or more limited partners provide financing for the venture and the general partners run the business. A limited partnership in this case protects the assets of silent partners by limiting their exposure and liability and acts as a conduit to pass current operating profits or losses on to them.
Most jurisdictions require limited partnership agreements to be in writing and, for the most part, contain the same provisions as those in a general partnership agreement-with some complex additions. Legal costs of forming a limited partnership can be even higher than for a corporation because in some states they are governed by securities laws.
Another aspect of limited partnerships is that in some businesses, the limited partner (also called the passive investor) may be subject to special tax liabilities that can offset the tax shelter advantages. The IRS tends to look at these facts on a case-by-case basis.
Limited partnerships file an IRS Form 1065 once a year. Individual limited and general partners include their allocable share of partnership income or loss on their individual income tax returns and pay taxes on that share based on their tax bracket. Partners cannot deduct losses greater than their basis in the partnership, which includes their investment plus any funds loaned to the partnership (except for real estate limited partnerships that are governed by special rules).
The 1986 Tax Reform Act limited the amount of losses a limited partner can deduct on a personal tax return. If the partnership is expected to generate tax losses in its early years, your CPA can help determine whether those losses will benefit you.