Second Circuit Adopts Management Test for Partner SE Tax Exception
The Second Circuit joins the Fifth in ruling that the limited partner exception to self-employment tax depends on a partner’s actual management role, not just their formal state-law title.
In Soroban Capital Partners LP v. Commissioner, the U.S. Court of Appeals for the Second Circuit affirmed the Tax Court and adopted a functional, management-based standard for the limited partner exception to self-employment tax. The court held that partners who run, manage, or exert control over a partnership are not 'limited partners' for tax purposes under IRC Section 1402(a)(13), regardless of their formal state-law designation. This decision has significant implications for investment managers, private equity funds, and other service partnerships that have historically relied on state-law status to shield partners' distributive shares from these taxes.
The ruling aligns with a recent Fifth Circuit decision, solidifying an emerging appellate consensus that rejects a bright-line test based on title alone. This creates uncertainty for partners whose involvement falls short of full-time management but exceeds that of a purely passive investor. Counsel should now scrutinize the actual roles of individual partners to assess tax exposure. The next development to watch is a pending appeal in the First Circuit, which could either confirm the trend or create a circuit split.