How Limited Must a Limited Partner be to Exclude Self-Employment Tax

On May 28, 2025, the U.S. Tax Court issued a memorandum opinion deciding that limited partners’ share of partnership income is subject to self-employment tax (Soroban Capital Partners LP v. Commissioner, T.C. Memo. 2025-52). This holding echoes other Tax Court decisions that certain limited partners were not acting as limited partners despite the partnership being organized as a state law limited partnership and therefore do not qualify for the exception to self-employment tax under Section 1402(a)(13).

The Tax Court’s Functional Analysis

This opinion follows the Tax Court’s initial 2023 ruling that state law classifications are not controlling in determining if the limited partner exception applies to exclude self-employment tax on partnership income. Again, the court applied a functional analysis (Soroban Capital Partners LP v. Commissioner, 161 T.C. No. 12). The parties submitted this case for decision without a trial, focusing on whether limited partners qualify for the self-employment tax exception using a functional analysis test.

Soroban Capital Partners LP proposed its own nine factor functional analysis that included whether the limited partner was treated as a limited partner under applicable state law as the first factor. However, the Tax Court responded that all facts and circumstances should be considered.

Specifically, the court stated,“. . .  [t]he test of whether a partner functions as a general partner or a limited partner for federal tax purposes is not dictated by any set number of factors. Rather, it is a facts and circumstances test that takes into account all relevant facts and circumstances.”

Key Arguments and the Court’s Response

The Tax Court emphasized that simply holding the title of limited partner does not determine tax treatment if the partner’s actions tell a different story. The opinion explains, “[l]abels are perhaps least relevant because they may be inconsistent with the economic reality of a partner’s relationship with the entity. A partner labeled a limited partner who works for the business full time, whose work is essential to generating the business’s income, who is held out to the public as essential to the business, and who contributes little or no capital, is not functioning as a limited partner regardless of the label placed on that partner.”

Soroban also argued that certain limited partners made capital contributions over several years, suggesting their partnership income was a return of capital. The Tax Court did not find this compelling when comparing the capital contributed to the partnership income received.

Ultimately, the court found that Soroban’s limited partners exercised managerial control, worked full time for the business and contributed little capital. The court held that such partners functioned more like employees than passive investors and did not qualify for the limited partner exception to self-employment tax.

Implications for Limited Partners and Previous Rulings

This ruling follows and reinforces prior decisions, including:

• Renkemeyer, Campbell & Weaver, LLP v. Commissioner, 136 T.C. 137 (2011)
• Denham Capital, Management, LP v. Commissioner, T.C. Memo 2024-114 (Dec. 23, 2024)
• Sirius Solutions v. Commissioner, Docket No. 30118-21 (November 28, 2023)

It’s important to know that while Soroban and Denham involve hedge funds and investment management firms, the Sirius Solutions case pertains to a consulting business and highlights the broader applicability of the court’s reasoning beyond investment-focused partnerships.

Additionally, in Sirius Solutions v. Commissioner, Docket No. 30118-21, the Tax Court issued an order and decision under Rule 251 in favor of the Commissioner, setting up a challenge in the Fifth Circuit Court of Appeals. Oral arguments for Sirius were held on February 6, 2025. Denham Capital Management, LP v. Commissioner, T.C. Memo 2024-114, has also been appealed, is currently pending before the First Circuit Court of Appeals.

Future Cases to Watch

Other limited partner cases remain before the Tax Court such as Hudson Bay Capital Management LP v. Commissioner, No. 4654-25 and Point72 Asset Management, L.P. v. Commissioner, No. 12752-23. These cases may further shape how the limited partner exception to self-employment tax is applied.

If you rely on limited partner classifications to manage self-employment tax exposure, now is the time to reassess. Contact us. We can help you evaluate your current structure and ensure compliance.

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