A limited partnership (LP) is formed by filing a Certificate of Limited Partnership with the relevant state authority. An LP must have at least one general partner and one limited partner. In most cases, the limited partnership will have only one general partner and many limited partners. Every limited partnership should outline the terms in a written limited partnership agreement (LPA) signed by the general partner and all limited partners.
A limited partnership provides personal liability protection for the limited partners. The liability of the limited partners is limited to their capital contributions. In contrast, with a general partnership, all partners have unlimited liability for partnership debts.
Most limited partnerships are set up for investment purposes and are popular with hedge funds, private equity, and real estate investment funds. The general partner is solely responsible for managing the LP, so the limited partners do not actively participate in the business operations.
For limited partnerships that receive income connected with an active trade or business, the ordinary income allocated to limited partners is generally exempt from self-employment income taxes under the Self-Employment Contributions Act (SECA).
The LP is not a taxable entity for federal tax purposes. The limited partnership files an annual Form 1065 (US Return of Partnership Income), which reports the partnership’s income, expenses, credits, and other tax items. The total amounts are then allocated to the partners and reported separately on a Schedule K-1 (Form 1065) for each partner. Each partner uses the information on Schedule K-1 to complete their income tax return.