2nd Circ. Narrows 'Limited Partner' Tax Exception
The Second Circuit has affirmed that the limited partner exception to self-employment tax depends on a partner's functional role, not their formal title under state law.
The U.S. Court of Appeals for the Second Circuit has affirmed the Tax Court’s decision in Soroban Capital Partners v. Commissioner, strengthening the IRS’s position on the self-employment tax exception for limited partners. The court held that the exception under Internal Revenue Code § 1402(a)(13) requires a functional analysis of a partner’s role. Partners who run, manage, or otherwise exercise control over the partnership’s business do not qualify as “limited partners” for tax purposes, regardless of their formal designation under state law. Because Soroban’s principals exercised managerial control, their distributive income shares were subject to self-employment tax. This ruling has immediate consequences for investment funds, professional service firms, and other entities structured as limited partnerships, particularly within the Second Circuit. The court noted its standard was similar to one recently adopted by the Fifth Circuit, but counsel should monitor a similar pending case in the First Circuit, which could create a circuit split and tee up the issue for potential Supreme Court review.