If you have ever invested in a partnership or started one with your cousin, your college roommate, or that one guy with the “million-dollar idea,” you’ve probably come across the term Limited Partner.
It sounds harmless. Low risk. Maybe even passive.
But this is where folks get tripped up:
If the IRS decides you’re not truly “limited,” you could be on the hook for self-employment taxes. And those are anything but passive.
What Is a Limited Partner?
A Limited Partner is like the quiet investor in the background. You put up some money, stay out of the day-to-day, and (ideally) collect your share of the profits while someone else handles the messy stuff.
Because you’re not “actively involved,” the IRS says you shouldn’t have to pay self-employment tax on that income.
Sounds great, right?
Well… zip up your rain jacket.
When the IRS Thinks You’re Active (Even If You Swear You’re Not)
If you’re signing checks, sitting in on strategy meetings, managing people, or acting like the boss (because, technically, you might be)… the IRS might decide you’re not actually a Limited Partner.
And when that happens? Boom. Self-employment tax. That’s 15.3% of your partnership income. Just like that.
So if you’re bringing in $100K from your partnership share, that’s $15,300 heading straight to Uncle Sam. Surprise!
How to Stay Truly Limited
Want to stay in the IRS’s good graces? Here’s how:
- Don’t have decision-making power
- Don’t manage daily operations
- Don’t personally guarantee business debts
- Don’t act like a general partner just because you’re passionate
In plain English: keep your name out of the meeting notes, your hands off the wheel, and your voice out of the group chat.
Already Active? No Shame. Just Plan for It.
If you’re doing more than just investing, you’re probably active. That means your profits may come with a self-employment tax tag. Better to know now than get blindsided later when the IRS shows up with a calculator and that signature suspicious look.
Partnership income is taxed differently depending on your role. Limited or active, you need to know which one you are. And just so we’re clear: the IRS already has an opinion. Your job is to make sure they are not wrong.
Still wondering what kind of partner the IRS thinks you are? Let’s sort it out together before it turns into an expensive guessing game.
