Tax Court Poised to Determine Who is a Limited Partner Under §1402(a)(13)
As reported in today’s issue of Tax Notes Today, yesterday the Tax Court took the side of the IRS in Soroban Capital Partners v. Commissioner, a case involving whether the income allocable to limited partners of a hedge fund manager, which partners also were general partners in the hedge fund manager and received guaranteed payments for services rendered, qualifies for the §1402(a)(13) exclusion from self-employment tax. First, the Tax Court held that being a limited partner under state law did not automatically cause the person’s allocable share of income to qualify for the SE tax exclusion, rather the court sided with the IRS that “[a] functional analysis test should be applied when determining whether the limited partner exception under section 1402(a)(13) applies to limited partners in state law limited partnerships.” Second, the Tax Court held that it had jurisdiction to make this limited partner determination in a partnership-level proceeding, rather than in a partner-level proceeding as asserted by the taxpayer.
The Tax Court’s holding does not yet tell us whether a service-providing partner will be entitled to any SE tax exclusion attributable to the partner’s capital in a limited partnership. In other words, will a taxpayer who wears two hats, one as a general partner and one as a limited partner who has contributed capital to the limited partnership, be entitled to any SE tax exclusion for income allocated to such partner that represents a return on that partner’s capital. We are now poised to find out the Tax Court’s view, which perhaps will address structures designed to separate income for services from a return on capital for §1402(a)(13) purposes. Stay tuned!