DEFINITION of ‘Limited Entrepreneur’
A limited entrepreneur is a person who is involved in a limited liability company but does not actively manage it. One benefit of being a limited entrepreneur is not having to pay self-employment tax. LLC owners must be careful to not allocate more than 35% of the LLC’s losses to limited entrepreneurs, otherwise the LLC would be classified as a syndicate and face different tax treatment.
BREAKING DOWN ‘Limited Entrepreneur’
Limited partners are similar to limited entrepreneurs in that they also do not play an active role in a company’s management and cannot be held responsible for any debts the company incurs. This means that any income or losses they receive from the business are usually considered passive for tax purposes.
How Limited Entrepreneurs Function
A limited entrepreneur is considered to be an individual with interest in a company other than a limited partnership but likewise does not take an active role in the management of the company. This is comparable to other business arrangements where an investor or other stakeholder distances themselves from the active management of the enterprise. The parameters of what constitutes active participation are not clearly enumerated, however regulations do state that a sign of the lack of active participation is that the limited entrepreneur has limited liability for the organization’s losses. The benefit of limited entrepreneurship is it allows individuals to hold interest in enterprises that they wish to reap certain benefits from while freeing themselves of the burdens of management, leadership, and debts while taking advantage of the passive activity rules of the tax code. This can affect the type and amount of dedication the individual can claim when filing their annual income taxes.
Certain stipulations from the Internal Revenue Service state limited entrepreneurs cannot have actively participated in the management of businesses they hold interest in for more than five years.
Under the tax code, a limited entrepreneur has other rights and restrictions they must adhere to maintain their classification. For instance, a limited entrepreneur involved holding, producing, or distributing motion picture films or video tapes, farming, exploring for oil and gas resources or geothermal deposits, or the renting of depreciable property can only group those activities, for tax purposes, with the same type of business. In other words, the limited entrepreneur could hold interest in more than one farm, however they would risk losing this classification if they attempted to group those activities with films for example.