General Partner vs. Limited Partner: Everything You Need to Know
A general partner is an owner of a partnership. Usually, a general partner is either a managing partner or active in the daily operations of the company. 7 min read
What is the difference between General Partner and Limited Partner?
The difference between a general partner vs. limited partner is a general partner is an owner of the partnership, and a limited partner is a silent partner in the business.
General Partner: What Is It?
A general partner is an owner of a partnership. Usually, a general partner is either a managing partner or active in the daily operations of the company. A general partner of a business can act on behalf of the company. While a general partner has significant duties and responsibilities in the partnership, he or she also has unlimited liability in terms of a partnership’s financial dealings. Therefore, if the partnership incurs significant financial debt or liability, such liability can pass through to the general partner(s). However, if the business operates as a limited partnership, only one of the owners will be deemed a general partner, and thus have unlimited liability.
Limited Partner: What Is It?
A limited partner, also referred to as a silent partner, has limited liability for the business’s debts and liabilities. Unlike a general partner, the amount of liability that a limited partner assumes is based on the amount of capital he or she contributes to the business. In addition to having limited liability, the limited partner also has limited responsibilities in terms of the daily operations of the business. Such limitations depend on the number of shares the limited partner owns. Generally, limited partners aren’t involved in the daily operations of the business nor do they participate in management meetings. However, if a limited partner spends in excess of 500 hours in a year assisting the limited partnership in its daily operations, he or she may be considered a general partner.
A partnership is an entity formed when at least two or more individuals agree to go into business with one another. More specifically, there are two main types of partnership structures:
- General partnership
- Limited liability partnership, also referred to as a limited partnership
There are no filing fees associated with establishing a partnership nor are partnerships required to hold meetings, prepare meeting minutes, appoint officers, or issue shares of stock. Keep in mind, however, that creditors can initiate legal proceedings against the partnership itself, including the assets of the partners, i.e. house or automobile.
General Partnership: An Overview
The most common type of partnership, a general partnership is arranged by two partners who will have unlimited liability, which means that their personal assets are liable to the partnership’s obligations and debts. The general partnership itself can be information — it can be as easy as a verbal agreement made over dinner. As long as the agreement is put into a written contract, you can create a general partnership.
There are no requirements to business formation with general partnerships. It is entirely up to the partners themselves to determine how to run the business. General partnerships are a particularly attractive type of business for those operating in the legal or medical field. For example, if two attorneys who operate as sole practitioners wish to expand their networks, they may choose to form a general partnership with the purpose of bringing their own specialized knowledge, expertise, and expansive network in hopes to further expand and develop their business.
However, a disadvantage of being a general partner, as previously noted, is the unlimited liability that you face. Therefore, you can be personally liable for the general partnerships’ debts and obligations to creditors, legal suits, and any other financial obligations that the general partnership is responsible for. For example, if someone brings a legal suit against the general partnership, both partners will be defendants in the suit. Moreover, even if you did not engage in any misconduct, if the court finds the general partnership guilty, then both general partners will be held financial responsible for the outcome of the suit.
Limited Partnership: Overview
Limited partnerships, or limited liability partnerships, are generally established for real estate purposes. When two or more partners form this kind a business, such partners will be liable only for the amount of capital each one invested into the business. Limited partners do not receive dividends but do in fact enjoy direct access to the flow of income and expenses. Generally, limited partners are not liable for the total and complete debts and obligations of the company.
While the limited partnership is different than a general partnership, the limited partners can enjoy general partner-like qualities, including the ability to manage the business like a general partner would as long as a formal contract is in place. Be mindful that limited partnerships will have at least one general partner who controls the daily operations of the business, and who will become ultimately liable for all business debts.
Advantages to Becoming a Limited Partner
Below are some advantages to becoming a limited partner:
- A limited partner can contribute financially to the business in exchange for a percentage of the partnership’s profits.
- A limited partner cannot incur the debts or obligations of the partnership in excess of the amount of capital invested into the business.
- A limited partner need not participate in the daily operations of the business or in management meetings.
- If a limited partner works in excess of 500 hours in a given year, he or she may be deemed a general partner. This can be an advantage for a limited partner who wishes to have more of a say in the company’s growth and development.
Disadvantages to Becoming a Limited Partner
- While it may be advantageous for you not to spend additional time participating in the daily operations of the business, it may also be disadvantageous, as you generally cannot make any important decisions regarding the company’s growth.
- A limited partner can invest a lot of money but still have no say in the business decisions.
- While working in excess of 500 hours/year can deem someone a general partner, the disadvantage will be the unlimited liability that a general partner incurs. Further, a limited partner may also be deemed a general partner in other circumstances as well. If, for example, a creditor can prove that the limited partner took action in the dealings of the company, then the partner may be deemed a general partner and thereby liable for such debts and obligations.
- A limited partner may lose his or her financial investment in the partnership.
LP Tax Treatment
The Internal Revenue Service (IRS) doesn’t treat limited partners’ shares of stock as earned income due to the fact that limited partners are not active in the daily operations of the business. But, the IRS does treat limited partnerships like general partnerships, and all partners must individually report and pay taxes on their share of profits since limited partners do not pay self-employment taxes.
Publicly Traded Partnership
A publicly traded partnership, also referred to as master limited partnership, is a limited partnership managed by two or more general partners that can be individuals, corporations, other partnerships. The business itself is funded by limited partners who provide financial assistance but have no management role in the development and growth of the partnership.
This type of partnership combines those tax benefits of a limited partnership with the liquidity of a publicly traded security. Due to certain limitations identified in the U.S. Code, publicly traded partnerships must operate in a specific type of business, i.e. petroleum or natural gas. To qualify as a publicly traded partnership, the partnership must generate at least 90 percent of its income from qualifying sources, which are determined by the IRS.
While there is no legal requirement to draft a written partnership agreement, you should still do so. If you fail to draft a written agreement, you risk potential legal issues in the future. You’ll be forced to abide by the default rules in your state’s partnership, which may not be favorable for you or your partner.
In addition, creating a partnership agreement will help you and your partner to discuss all aspects of the business, including the operation, accounting records, as well as any other issues that may arise in the development and growth of your partnership. With that being said, the agreement doesn’t have to be lengthy or complex; it can be a rather simple one.
Differences Between a Partnership and an LLC
While a partnership is rather straightforward, there are unique qualities of establishing a limited liability company (LLC). While a partnership doesn’t require any paperwork, aside from a written agreement between the parties, an LLC is required to file additional paperwork, which includes the articles of organization. This document must be filed with the respective state’s secretary of state or department of corporations. You must also comply with all other requirements for that particular state.
Another difference between a partnership and an LLC is that partners are personally liable to the business’s debts whereas partners in a limited liability company cannot be held personally liable for the financial obligations of the LLC. Therefore, creditors cannot go after the partners’ personal assets for those operating an LLC.
While there are key differences in a general partnership and an LLC, there is one similarity. Both types of entities offer pass-through taxation, which means that the owners will report business earnings and losses on their individual tax returns. The partnership and LLC do not pay taxes.
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