Taxes
The Tax Court's recent ruling in Soroban Capital Partners has significant implications for determining whether a limited partner's distributive share qualifies for the self-employment tax exception under Section 1402(a)(13). The court mandated a functional analysis of the limited partner's role in the partnership, but didn't specify the exact criteria for this analysis.
Two main approaches emerge from existing case law and regulations. The Control Test focuses on the partner's control over partnership operations. This aligns with the Revised Uniform Limited Partnership Act (RULPA) and state laws defining limited partners. Under this test, activities like consulting, voting on major decisions, or being an employee wouldn't disqualify a partner from the employment tax exemption, but exercising daily managerial control might.
The Activity Test, emphasized in some Tax Court decisions, considers the extent of the partner's participation in partnership activities, regardless of control. It may disqualify partners who are active in the business beyond passive investment.
The 1997 proposed regulations (never finalized) suggested disqualifying partners who have personal liability for partnership debts, can contract on behalf of the partnership, or participate in the partnership's trade for over 500 hours annually. While these regulations aren't binding, they might influence IRS positions.
For tax preparers, several key considerations emerge. It's crucial to review limited partnership agreements for provisions granting excessive control to limited partners. Partners' activities should be assessed against RULPA guidelines and state laws. Activities listed in RULPA Section 303(b) generally shouldn't disqualify a partner. Limiting partners' participation to under 500 hours annually may align with proposed regulations.
It's important to note that holding both limited and general partnership interests doesn't automatically disqualify the limited interest from the exception. Tax preparers should monitor developments in this area, including potential new Tax Court decisions or regulations a keep in mind that a simple delineation between limited and general partners is not enough to conclusive make a determination on employment taxes.
When in doubt about a partner's status, consider the conservative approach of treating distributive shares as subject to self-employment tax. Remember that guaranteed payments for services are always subject to self-employment tax, regardless of partner status.
The application of Section 1402(a)(13) remains fluid. Tax preparers should stay informed about new developments and work closely with clients to assess their specific situations. While the Soroban decision provides some clarity, it also leaves many questions unanswered, necessitating careful analysis and potentially conservative treatment of partnership distributions in uncertain cases.
Christine Gervais is a licensed CPA, using her skills to help businesses grow and achieve their fullest potential. Christine has a Master’s degree in accounting from Southern New Hampshire University in addition to holding her CPA license for over a decade. Notably, Christine is a nationally recognized speaker providing education to other CPAs on how to best serve clients as well as instruction on a wide variety of topics for business owners on how to maximize success. Christine prides herself on the value she can bring to clients with her extensive tax knowledge and provides strategic, forward-thinking financial strategies to help clients grow. When not behind her desk, you can find Christine spending quality time with her daughter and stepson or tending to the family’s excessively loved farm animals.
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