On November 28, 2023, the US Tax Court granted partial summary judgment in favor of the Internal Revenue Service (IRS) in Soroban Capital Partners LP v. Commissioner and held that “limited partners” are defined functionally—not by state law—for purposes of Internal Revenue Code (IRC) Section 1402(a)(13), which excludes distributions to a “limited partner, as such” from self-employment tax.
Partners are generally required to include their distributive shares of partnership income in their net earnings from self-employment under IRC Sections 1402(a) and 702(a)(8). IRC Section 1402(a)(13), however, provides an exception. It excludes “the distributive share of any item of income or loss of a limited partner, as such, other than [certain] guaranteed payments” from self-employment tax. However, in the context of IRC Section 1402(a)(13), “limited partner” is not defined. The Tax Court previously held that “limited partners” are determined functionally (e.g., by what they actually do with respect to the partnership), not by their status or title under state law, in the context of a limited liability partnership. (See Renkemeyer v. Commissioner, 136 T.C. 137 (2011).) Soroban argued that in the distinct context of a limited liability partnership, plain statutory meaning, legislative history, past guidance from the US Department of the Treasury (Treasury) and the IRS, and policy considerations all pointed to the same conclusion: “limited partner” for purposes of the self-employment tax must be determined by reference to state law.
The Tax Court disagreed. The Court fixed its attention on the phrase “limited partner, as such” and found that under the canon of construction against surplusage, the words “as such” demonstrate “that the limited partner exception applies only to a limited partner who is functioning as a limited partner.” To the extent legislative history or Soroban’s “myriad other arguments” suggest otherwise, they cannot “overcome the plain meaning of the statute.”
The Tax Court held that IRC Section 1402(a)(13) applies only to “passive investors” and excludes “earnings from a mere investment” only. Therefore, the Court “must examine the functions and roles of the limited partners in the partnership to determine whether their shares of earnings are excluded from net earnings from self-employment.” The Court concluded that it has jurisdiction to complete this task during partnership-level proceedings because the applicability of IRC Section 1402(a)(13) “is a partnership item” under Treasury Regulation § 301.6231(a)(3)-1.
Practice Point: The Court’s holding in Soroban will likely provide the IRS with additional incentive to audit taxpayers as part of the IRS’s Self-Employment Contributions Act compliance campaign, which the IRS placed on hold to see “what develops in” cases like Soroban. This issue has been hotly contested in the Tax Court, with several cases currently being litigated, including Denham Capital Management LP v. Commissioner, Docket. No. 9973-23, and Point72 Asset Management LP v. Commissioner, Docket. No. 12752-23. We will see whether the taxpayer in Soroban seeks review by an appellate court. In the meantime, if you have this issue, we advise consulting with your tax professional to ensure you are poised to defend your position if and when the IRS comes knocking!
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