On May 28, in the case of Soroban Capital Partners LP v. Commissioner, T.C. Memo 2025-52, the U.S. Tax Court determined that active limited partners may not qualify for the limited partner exception under IRC Section 1402(a)(13), and thus may be subject to self-employment tax on their distributive shares of partnership income.

Summary

While partners typically must report their net earnings from self-employment income for purposes of the self-employment tax, IRC Section 1402(a)(13) provides an exception to this rule for the distributive share of income from a limited partner. Many fund managers have structured their management companies as limited partnerships and rely on this exception to avoid self-employment taxes on allocated income, and only pay self-employment tax on their guaranteed payments.

The term “limited partner” is not defined in the code, and the IRS has taken the approach that active limited partners do not qualify for this exclusion simply because they are classified as a limited partner. 

The court has previously held in prior motions for summary judgement that a functional analysis is needed to determine the roles and responsibilities of the partners to determine who is functioning as a limited partner. When the court looked at the partners of Soroban, it determined that the limited partners worked full time for the partnership’s business, exercised managerial control, and contributed little to no capital relative to their shares of such income. Based on these and other factors, the court determined that Soroban’s limited partners were not acting as limited partners, and as such they are subject to self-employment tax.

What does CohnReznick think?

In the case of Soroban, as well as another recent case, the tax court looked at substance over form and determined that being classified as a limited partner under state law is not determinative. Using a functional analysis test, taxpayers will need to look at the actual role these partners have in the business.

Fund managers still relying on the 1402(a)(13) exception will continue to face tax risk and uncertainty as this case as well as several other cases currently being litigated on this topic work their way through the court and appeals process. We will continue to monitor this situation as it evolves, and taxpayers should work with their tax advisors to see if any changes to structure or filing positions should be considered given the outcome of these recent cases.