A general partner runs the business and is personally liable for its debts; a limited partner invests capital, stays passive, and can only lose what they put in. That single trade-off between control and risk is the difference between a general partner and a limited partner, and it drives everything else — how profits get split, who pays self-employment tax, and who can be sued when something goes wrong. The structure shows up most often in private equity, venture capital, and real estate funds, where professional managers need large pools of patient capital from investors who don’t want to run anything.
Who Runs the Business
The general partner holds full authority over the partnership’s operations. That means signing contracts, making investment decisions, managing assets, hiring staff, and taking on debt. The partnership agreement can carve out specific limits, but absent those restrictions the general partner’s discretion is broad.
That authority carries legal obligations. General partners owe fiduciary duties of loyalty and care to the limited partners and the partnership itself. The duty of loyalty means the general partner cannot steal opportunities from the partnership, compete with it, or deal with it as an adversary. The duty of care rules out grossly negligent or reckless decisions. A partnership agreement can modify these duties within limits, but the implied obligation of good faith and fair dealing cannot be eliminated.
Why Limited Partners Stay Passive
Limited partners are passive investors by design. Historically, state law imposed a “control rule” that stripped limited partners of their liability protection if they got too involved in managing the business. Under the Revised Uniform Limited Partnership Act of 1976, states created safe harbor lists of activities that would not trigger liability: advising the general partner, voting on major transactions like selling all partnership assets, inspecting the books, and voting on whether to admit or remove a general partner.
Signing contracts on the partnership’s behalf, directing employees, or making binding operational decisions fell outside the safe harbor and could cost a limited partner the liability shield.
The Uniform Limited Partnership Act of 2001 eliminated the control rule entirely, giving limited partners a full liability shield regardless of whether they participate in management. A growing number of states have adopted this newer version, but some still operate under the older framework. If you’re investing in or forming a limited partnership, confirming which version your state follows matters.
Who’s on the Hook
The General Partner Has Unlimited Personal Liability
The general partner is personally responsible for every debt and obligation of the partnership. If the partnership loses a lawsuit or defaults on a loan, creditors can reach the general partner’s personal bank accounts, real estate, and other assets. That exposure is the price of control.
Almost nobody accepts that risk directly. The standard workaround is to form an LLC or corporation to serve as the general partner, with the individual managers owning the LLC rather than serving as general partner themselves. If the partnership faces a claim, creditors can reach the LLC’s assets but not the personal assets of the people behind it.
That corporate shield is not bulletproof. Courts can pierce it if the entity is treated as an alter ego of the individuals behind it. The usual triggers are mixing personal and business funds, underfunding the entity at formation, or using it to commit fraud. Separate bank accounts, entity meetings, and adequate capitalization in the LLC are how managers keep the shield intact.
The Limited Partner’s Loss Is Capped
A limited partner’s maximum loss equals the capital they contributed or committed to contribute. If the partnership collapses, creditors cannot pursue the limited partner’s personal assets. This cap is the whole reason investors accept the LP role, and it holds as long as the limited partner does not cross into active management in states that still enforce the control rule.
The LLLP Middle Ground
About half the states now recognize a variant called the Limited Liability Limited Partnership. An LLLP works like a regular limited partnership except the general partner also gets liability protection similar to an LLC member. The general partner in an LLLP is not personally liable for partnership debts simply by virtue of being general partner, which eliminates the need for the LLC-as-general-partner workaround. States that don’t authorize LLLPs still require them to register before doing business there, so the structure has some portability.
Who Puts In the Money
Limited partners supply the vast majority of the capital. In a typical private equity or venture capital fund, the general partner contributes somewhere between 1% and 5% of total committed capital. The general partner’s real contribution is expertise, deal sourcing, and willingness to bear management risk.
Capital is rarely contributed all at once. The partnership agreement includes a capital call schedule, and the general partner issues calls over time as investment opportunities arise. Missing a capital call can trigger severe penalties, including forfeiture of part of the limited partner’s interest, so the commitment is treated as binding even though the cash moves in installments.
Limited partners almost always contribute cash. General partners may contribute cash, property, or in some cases the economic value of services they commit to provide. The partnership agreement specifies what counts.
Who Gets Paid What
Money flows back to partners through the distribution provisions of the partnership agreement, commonly called the “waterfall.” It’s designed to reward the general partner for active management and risk while giving limited partners the majority of investment returns.
Management Fees
The general partner charges an annual management fee to cover operating costs and pay the management team. In private equity, this fee runs roughly 1.5% to 2% of committed capital during the investment period, and smaller or first-time funds sometimes charge up to 2.5%. The fee is paid regardless of performance, so limited partners treat it as a fixed cost.
Carried Interest
Carried interest is the general partner’s share of investment profits and works as the primary performance incentive. The industry convention, often called “2 and 20,” gives the general partner 20% of profits after limited partners receive their capital back plus a preferred return.
The preferred return, or hurdle rate, is the minimum annual return limited partners must earn before the general partner takes any carry. In private equity, roughly 80% of funds set this at 8%. Credit and real estate funds often use lower hurdles in the 5% to 7% range. Until the hurdle is cleared, 100% of distributions go to the limited partners.
Limited Partner Distributions
Once the hurdle is met, limited partners receive the remaining 80% of profits. Their returns are entirely passive and tied to the performance of the underlying investments. A well-structured waterfall also includes a “catch-up” provision that lets the general partner receive a larger share of distributions for a period after the hurdle clears, until the cumulative split reaches 80/20.
How Each Is Taxed
A limited partnership does not pay federal income tax at the entity level. It files an informational return on IRS Form 1065 and passes all income, losses, deductions, and credits through to the individual partners.1Internal Revenue Service. Partnerships Each partner reports their share on their personal return using the Schedule K-1 they receive from the partnership.2Internal Revenue Service. Partner’s Instructions for Schedule K-1 (Form 1065) (2025)
Self-Employment Tax Is the Big Divide
The tax distinction between general and limited partners that hits the most wallets is self-employment tax. Under federal law, a limited partner’s distributive share of partnership income is excluded from self-employment tax. The only exception is guaranteed payments for services the limited partner actually performs for the partnership.3Office of the Law Revision Counsel. 26 USC 1402 – Definitions General partners pay self-employment tax on their distributive share because their income is treated as active.2Internal Revenue Service. Partner’s Instructions for Schedule K-1 (Form 1065) (2025)
Self-employment tax covers Social Security and Medicare and runs 15.3% on the first $176,100 of net earnings in 2025, with the 2.9% Medicare portion continuing on all earnings above that. For a general partner earning substantial management income, that adds up quickly, and it’s one reason many fund managers pay close attention to how their compensation is structured.
The Three-Year Rule on Carried Interest
Carried interest received by a general partner faces an additional tax wrinkle. Under Section 1061 of the Internal Revenue Code, capital gains allocated through a carried interest must meet a three-year holding period to qualify for long-term capital gains rates. Gains on assets held between one and three years are recharacterized as short-term capital gains and taxed at ordinary income rates.4Office of the Law Revision Counsel. 26 USC 1061 – Partnership Interests Held in Connection With Performance of Services The rule was added by the Tax Cuts and Jobs Act in 2017, extending the standard one-year holding period specifically for fund managers.5Internal Revenue Service. Section 1061 Reporting Guidance FAQs
Limited partners are not affected by Section 1061 because their returns come from their capital investment, not from a performance-based interest received in exchange for services.
Getting Out
Limited partnership interests are not liquid. You cannot sell an LP stake the way you’d sell publicly traded stock. Nearly every partnership agreement restricts transfers, typically requiring the general partner’s written consent before an interest can be assigned to a third party. Some agreements carve out exceptions for transfers to family members, trusts, or affiliated entities, but outright sales to outsiders are tightly controlled.
Voluntary early withdrawal is even harder. Under most partnership agreements, a limited partner cannot withdraw before the stated term unless the agreement specifically allows it. The general partner’s interest is stickier still, because their departure can trigger dissolution of the entire entity. Anyone entering a limited partnership should treat their capital as locked up for the full term, which in private equity typically runs 10 to 12 years.
Side by Side
The differences come down to five dimensions:
- Control: the general partner manages everything; the limited partner has no operational authority.
- Liability: the general partner faces unlimited personal liability; the limited partner’s loss is capped at their investment.
- Capital: limited partners contribute the bulk of the money, often 95% or more; the general partner contributes expertise and a small capital stake.
- Compensation: the general partner earns management fees and carried interest; the limited partner earns passive returns from distributions.
- Taxes: the general partner pays self-employment tax on distributive income; the limited partner does not.3Office of the Law Revision Counsel. 26 USC 1402 – Definitions
Both types of partners receive Schedule K-1s reporting their share of the partnership’s income, and neither pays tax at the entity level.1Internal Revenue Service. Partnerships The structure holds together because each side gets something the other cannot easily replicate. Investors get liability protection and passive returns. Managers get access to large capital pools and performance-based upside.