There has been more focus on self-employment tax in recent years than in many years prior. There is ongoing litigation on what "limited partner, as such" under Section 1402(a)(13), added in 1977, means. This special rule provides that net earnings from self-employment does not include the distributive share of any item of income or loss of a limited partner, as such, other than guaranteed payments for services actually rendered to or on behalf of the partnership.
Does limited partner mean that under state law you are a limited partner, or does it depend on what the partner does? After all, Congress did not just say "limited partner," it wrote "limited partner, as such." Most limited partners are not involved in partnership operations, but some (as hinted at in (a)(13) above) are providing services for which they receive a guaranteed payment. Some "limited partners" might be involved in some key activities of the partnership such as in a recent case - Denham Capital Management LP, TC Memo 2024-114 (12/23/24). As noted by the Tax Court: "The Partners treated their work for Denham as their full-time employment. Each of the Partners participated in the management of Denham in some way."
In this case, the court agreed with the IRS that these limited partners were not limited partners as such. They found these partners were operating the business in a way that Congress would view them as subject to SE tax.
There are other cases in appeals, such as Soroban Capital Partners LP, 161 TC 310 (2023).
In January 2025, the IRS updated its training materials on SE tax and partners with lots of background on the relevant law and issues.
A few observations:
These limited partnership cases involved lots of dollars - well beyond the Social Security wage/SE base which is $176,100 for 2025, so the issue is whether the limited partners owe Medicare tax of 2.9% on their distributive share + the 0.9% additional Medicare tax under Section 1401 for a total of 3.8%.
What isn't addressed in the cases is the Section 1411 net investment income tax (NIIT) and application of Section 469, passive activity loss limitation. Because the limited partners worked over 500 hours in the partnership, assuming it was just one activity, they are material participants so the income is non-passive (active) and not subject to the NIIT (Reg. 1.469-5(f)). If on appeal, these partners win and are not subject to SE tax, they still won't owe the NIIT.
The FY2025 Treasury Greenbook under President Biden includes a proposal (also suggested by others), that basically would find that income above the Section 1411 and 1401 thresholds ($200K if Single, $250K if MFJ) will be subject to either the additional Medicare tax (total rate of 3.8%) or the NIIT (also at 3.8%). See page 73 of the Greenbook.
Will we see any clarification or change to Section 1402(a)(13) to perhaps not only address what "limited partner" means but also how Congress thinks this applies to LLC members (the IRS and Tax Court apply a functional analysis to LLC members as well as to limited partners as such). This can't happen in the upcoming tax bill which will be handled via the budget reconciliation process because one of several limitations on this approach which allows only 51 votes in the Senate rather than 60, it that it can't address Social Security.
I don't think we'll see separate legislation on this topic but we should see more rulings including from courts of appeals.
What do you think?
