Tax Court Rules Against Limited Partners on SECA

On May 28, the Tax Court held in Soroban Capital Partners LP v. Commissioner that state-law limited partners actively involved in the operation of the company are subject to self-employment taxes because they did not meet the limited partner exception under Section 1402(a)(13). The decision is consistent with earlier decisions by the Tax Court.

Background

Section 1402(a)(13) of the Self-Employed Contributions Act (SECA) excludes from net earnings subject to self-employment tax the distributive share of income of a “limited partner, as such,” other than guaranteed payments for services (limited partner exception). For decades, limited partners in state-law limited partnerships have relied on the limited partner exception. In 2023, the Tax Court ruled on a motion for summary judgment in Soroban v. Commissioner that limited partners in a state-law limited partnership were not eligible for the limited partner exception. The court explained that eligibility for the limited partner exception was not determined by the state law classification of the partner and partnership, but it instead is determined under a functional analysis inquiry to ascertain the roles and responsibilities of partners to determine their status for tax purposes. The functional analysis test originally was applied by the Tax Court in Renkemeyer, Campbell & Weaver LLP v. Commissioner to determine whether partners in a limited liability partnership were limited partners for purposes of the limited partner exception.

Other Tax Court decisions

The Tax Court’s ruling in Soroban is the latest in a string of cases in which the Tax Court has held that eligibility for the limited partner exception is not automatic for state-law limited partners but, rather, is subject to a functional analysis to determine whether partners were acting in a limited partner capacity. If the taxpayers in Soroban appeal the Tax Court’s decision, the case would be heard by the U.S. Court of Appeals for the 2nd Circuit. Previous Tax Court decisions consistent with the decision in Soroban have already been appealed to the U.S. Court of Appeals for the 1st Circuit (Denham Capital Management LP v. Commissioner) and 5th Circuit (Sirius Solutions v. Commissioner). In February, the 5th Circuit heard oral arguments in Sirius and appeared skeptical of the government’s argument that a functional analysis was required. A decision from the 5th Circuit is expected soon.

Crowe observation

Each circuit court will separately decide the issue. A split in the circuits sets up the potential for the issue to go to the Supreme Court.

Looking ahead

While Soroban is the Tax Court’s most recent decision in this area, the court has been consistent in its position that a functional analysis test applies in determining whether limited partners, regardless of state law form, are eligible for the limited partner exception under Section 1402(a)(13). With appeals pending in multiple circuit courts, uncertainty will remain for limited partners in the near future. Limited partners should continue to monitor developments in this area and consult their tax advisers to evaluate whether they are eligible for the Section 1402(a)(13) exception.