The IRS has increased its compliance efforts with the objective of accurate reporting and payment of Self-Employment Contributions Act (SECA) taxes. This pertains specifically to individual partners who hold the status of a “limited” partner but may not necessarily meet the criteria of a limited partner.
Limited Partner Exception
IRC Section 1402(a)(13) provides an exclusion to net earnings from self-employment for “the distributive share of any item of income or loss of a limited partner, as such, other than guaranteed payments described in section 707(c) to that partner for services actually rendered to or on behalf of the partnership to the extent that those payments are established to be in the nature of remuneration for those services.”
The term "limited partner" remains undefined, and the lack of a precise definition may potentially lead to the underreporting of net earnings from self-employment. Limited partners are exclusively passive investors and are prohibited from active participation in the partnership's operations. If a partner, despite the status of a "limited" partner actively engages in the activities of a state law limited partnership, the partner must report their distributive share of income or loss from the partnership as net earnings from self-employment, thereby subject to SECA tax.
Soroban Capital Partners v. Commissioner
On November 28, 2023, in Soroban Capital Partners v. Commissioner, the IRS challenged Soroban Capital Partners’ exclusion of the limited partners’ shares of ordinary business income from SECA tax due to the ambiguity in the functions and roles of these partners within the partnership. The Tax Court issued an opinion that agreed with the IRS’s position that IRC Section 1402(a)(13) does not apply to a limited partner who is “limited in name only”.
Functional Analysis Test
A functional analysis test, similar to Renkemeyer, Campbell & Weaver, LLP v. Commissioner, may be required to evaluate the actual roles, responsibilities and active involvement of the partners within the partnership. This analysis may examine whether a partner is genuinely passive or if their activities align more with those of a general partner.
Taxpayers relying on the limited partner exception are advised to seek guidance from their tax advisers for a comprehensive discussion on the implications of the Tax Court's decision in Soroban Capital Partners LP v. Commissioner and Renkemeyer, Campbell & Weaver, LLP v. Commissioner.
Evolved is a tax compliance and advisory firm with offices in New York City, Philadelphia and Stamford, serving clients nationally throughout the US. We provide tax provision, private equity and venture capital services alongside advisory for high net-worth tax and family office tax.
