Tax Court rules state law limited partner may be subject to self-employment tax

by | Dec 1, 2023

ARTICLE | December 01, 2023

Executive summary: Limited partner exception from self-employment tax

In ruling on a motion for partial summary judgment in a case involving a hedge fund manager (Soroban Capital Partners, LP), the Tax Court that holding a state law limited partnership interest is not, by itself, enough to avoid self-employment tax by way of the statuory exemption for ‘limited partners’. In reaching that decision, the Tax Court held that instead a ‘functional analysis’ must be applied, viewing state law limited partners in a similar manner as LLP and LLC members. A ‘functional analysis’ test would inolve a detailed factual analysis of the rights, obligations and responsibilities of the member to determine if they should be viewed as ‘acting as a limited partner.’

While this ruling was an important guidepost in both the case before the court, and for the taw law at large, argument are still to come in this case as to whether the taxpayer qualifies for the limited partner exception in light of this ruling, using the ‘functional analysis’ test. In addition, several similar cases involving investment fund managers are also pending before the Tax Court. Finally, this ruling is subject to appeal, and the Tax Court is only one of several venues in which taxpayers can litigate their tax liability—although it is the only venue in which judicial review can be obtained before payment of the disputed liability.

Tax Court rules state law limited partner may be subject to self-employment tax


The Tax Court, in Soroban Capital Partners LP, Soroban Capital Partners GP LLC, Tax Matters Partner v. Commissioner, has recently held that a partner’s state law status as a limited partner in a state law limited partnership, was, by itself, insufficient in determining whether the partner’s distributive share of ordinary business income was exempt from self-employment tax under the longstanding limited partner exception of section 1402(a)(13).  Granting partial summary judgment for the government, the court held that the limited partner exception should not “…apply to a partner who is limited in name only,” and that a “…functional analysis test should be applied when determining whether the limited partner exception under section 1402(a)(13) applies to limited partners in state law limited partnerships.”

Although limited partnership structures are not exclusive to the investment fund management industry, this case was the first of several self-employment tax cases involving investment fund managers on the Tax Court’s upcoming docket. Although arguments are still to come in all of these cases, fund managers who are relying solely on their status as state law limited partners in claiming an exemption from self-employment tax should know that the Tax Court—notably only one of multiple venues where a taxpayer can litigate their tax liability—has made its views very clear.

The case

Soroban Capital Partners LP (Soroban), an investment firm based in New York and organized as a Delaware limited partnership, was originally formed as an LLC but subsequently converted to a Delaware limited partnership at the beginning in 2015. During the years at issue Soroban had four total partners for federal income tax purposes – one general partner and three limited partners.  In addition to each partners allocable share of partnership income, the Soroban limited partners received guaranteed payments in exchange for the performance of services to Soroban.

For the tax years at issue, Soroban reported net earnings from self-employment to the limited partners equal to their guaranteed payments, but did not report each partner’s distributive share of the partnership’s ordinary business income as earnings from self-employment under argument that the statutory limited partner exception applied to such earnings.  Service disagreed with this position, and issued a Notice of Final Partnership Administrative Adjustment increasing Soroban’s net earnings from self-employment for each limited partner’s distributive share of ordinary business income.

The Tax Court ultimately granted summary judgment for the government, holding that “…determining whether a partner is a limited partner in name only requires an inquiry into the functions and roles of the limited partner.”  In reaching this conclusion the court focused first on the statutory construction of the exception, noting that “If Congress had intended that limited partners be automatically excluded, it could have simply said ‘limited partner.’ By adding ‘as such,’ Congress made clear that the limited partner exception applies only to a limited partner who is functioning as a limited partner.”

The court also looked to the legislative history of the exception, ultimately disagreeing with Soroban’s arguments that such history served to support the view that Congress intended the limited partner self-employment exception of section 1402(a)(13) to apply to all state law limited partners, irrespective of the nature of their activities with respect to the partnership.


The limited partner exception was enacted in 1977, and aside from a set of proposed regulations issued in 1997 but never finalized, there has been almost no guidance regarding the definition of “limited partner” for purposes of this exception, at least for state law limited partnerships (previous cases have addressed LLPs and LLCs). This is the first promulgated authority to suggest that a state law limited partner may not be a limited partner for self-employment tax purposes.

And while this case may create an additional test for taxpayers to navigate when determining whether the section 1402(a)(13) self-employment exception would apply to state law limited partners in a state law limited partnership, it should be noted that the court has yet to rule on whether or not the partners in the case were limited partners under their ‘functional analysis test’ – instead granting only summary judgment for the government that a functional analysis test should apply in determining whether a state law limited partner is, in fact, a limited partner for purposes of the section 1402(a)(13) self-employment exception.

Although the 1997 proposed regulations were never finalized, they were also never withdrawn and may be viewed as continuing to portray the views of IRS and Treasury on who should qualify as a limited partners, regardless of their status under state law. Although not identical to the ‘functional analysis test’ that the Tax Court has applied in similar self-employment tax cases involving LLC’s, these regulations may provide guideposts for investment fund managers and others looking to restructure their company interests in light of the Tax Court’s decision.

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This article was written by Nick Passini, Ben Wasmuth, Kyle Brown and originally appeared on 2023-12-01.
2022 RSM US LLP. All rights reserved.

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