Section 1402(a)(13) of the Tax Code was enacted clear back in 1977 that states that limited partners only owe self-employment tax on their guaranteed payments. However, the Code did not clarify what is a limited partner.
The IRS issued two sets of proposed regulations trying to clarify what is a limited partner, however, none of those regulations were ever finalized and it’s been over 25 years since the last proposed regulation.
Related article: How Should Crop Insurance Deferral Be Reported for ERP and PARP?
There have been a couple of Tax Court cases dealing with this issue and essentially if a limited partner is working full-time in a service business, then all of the business income is subject to self-employment tax.
We now have a new case winding its way through the Tax Court system. The Soroban Capital Partners LP v. Commissioner assert that a state issued limited partnership by default shields the imposition of SE tax on its limited partners other than any guaranteed payments.
Related article: Many Partnerships Still Need to Prepare Tax Schedules K2/K3
They stress that the Tax Code is very specific that any “limited partner” is exempt from SE tax. However, the Tax Court has disagreed in the past and I personally do not think they will win their case. But we will keep you posted.
