Distributable Share of Income and Self-Employment Tax for Limited Partners

A recent Tax Court ruling in Soroban Capital Partners Op, et al v. Commissioner, 161 T.C. No. 12, Nov. 28, 2023 examined if a limited partner's share of partnership profits is exempt from self-employment tax under Sec. 1402(a)(13). This provision generally excludes limited partners' distributive shares from self-employment income, except for guaranteed payments for services rendered.

The court emphasized the need to analyze the partner’s role and function within the partnership to determine eligibility for this tax exclusion. Historically, under state law, limited partners lose their limited liability if they control the partnership's business. The Revised Uniform Limited Partnership Act (RULPA) of 1976 outlined activities that do not constitute control, suggesting that limited partners who avoid managerial roles should qualify for the tax exemption.

Past cases involving LLPs and PLLCs have influenced the interpretation, often focusing on partners' activities rather than their control over the business. The Tax Court's decisions in Renkemeyer, Campbell & Weaver, LLP v Commissioner, 136 T.C. 137, 2011 and Castigliola v. Commissioner (T.C. Memo. 2017-62) show a preference for examining the extent of partners' participation in business operations to determine tax liability.

The IRS issued a proposed regulation in 1997 outlining conditions under which an individual would not be treated as a limited partner, including personal liability, authority to contract, or participation in business for more than 500 hours annually. Though not finalized, these guidelines suggest avoiding excessive control or contractual authority to maintain limited partner status.

In summary, limited partners must avoid significant control or excessive participation in the partnership's daily operations to qualify for the self-employment tax exclusion under Sec. 1402(a)(13). This ongoing legal interpretation necessitates careful review and potential adjustments to partnership agreements to ensure compliance and tax benefits.