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VideoThe Tax Navigator – Soroban Case Update: What it Means for the Limited Partner Exception and Self-Employment Tax
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In this episode of The Tax Navigator, Sean Muller discusses recent developments in the Soroban case and what they could mean for the limited partner exception to self-employment tax. He examines oral arguments before the Second Circuit, the debate over applying a functional test to determine limited partner status and the potential for a circuit split with the Fifth Circuit’s taxpayer-favorable Sirius decision. Sean also shares perspectives on the broader implications for partnerships, fund managers and future Treasury and IRS guidance.
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Detailed Description of The Tax Navigator – Soroban Case Update: What it Means for the Limited Partner Exception and Self-Employment Tax
00:00:00
Sean: We do have an update on the limited partner exception dealing with the Soroban case in the Second Circuit. For those of us in the Fifth Circuit, we had the Sirius case, which was taxpayer-friendly, but there’s the Soroban case that is not taxpayer-friendly.
00:00:16
Sean: They looked at the limited partner exception and said it doesn’t apply. You have to apply a functional test.
00:00:21
Sean: Even though the statute allows for limited partners not being subject to self-employment tax, in this case, the managers of the fund were held liable for self-employment tax, and so they’re appealing that.
00:00:34
Sean: And they’re saying that you really should be looking to the Sirius case and not applying a functional test. They’re also making an argument that the partnership cannot determine the self-employment tax liability of the partners. That’s a partner-level item, and so the courts have overstated the partnership’s ability to do that.
00:00:57
Sean: That case is on appeal right now. They had oral arguments with the panel of three judges last week. It does not look good for taxpayers based on what the judges have said.
00:01:07
Sean: The judges all asked for the IRS to rule in this case because the only favorable part of this is they don’t want to have a split between the Second Circuit and the Fifth Circuit, but none of them agree on anything other than applying the functional test.
00:01:24
Sean: They all were arguing that a limited partner is limited to what they can talk about and deal with in management. It’s truly a limited partner.
00:01:32
Sean: At one point, they even talked to the defense counsel and said, “Come on. You learned in law school what a limited partner is, and that means you weren’t very involved in the business.” It’s not looking good for taxpayers, at least in the Second Circuit.
00:01:45
Sean: The prediction right now from certain commentators is that the Second Circuit will uphold the ruling of the IRS and treat these partners as subject to self-employment tax, and then we’ll just have a split between the Second and Fifth Circuits.
00:01:58
Sean: And then they’re just going to continue to push on Treasury and the IRS to change their rules to make limited partners further defined so we’re not dealing with it.
00:02:08
Sean: The courts also were very concerned. They made a comment that, in this case, it’s very clear that the managers should be subject to self-employment tax, in their opinion.
00:02:18
Sean: But they said once you set that, then you have a slippery slope because somebody else may not be as close. They are worried about the ramifications. They are worried about the circuit split, but it’s not looking very taxpayer-friendly right now.
This episode of The Tax Navigator was recorded prior to publication. Some references or updates discussed may reflect information current as of the recording date.
