Limited Partner Self-Employment Tax: Who Owes It Now

A federal appeals court ruled on September 17 that three partners who ran an investment firm owe self-employment tax on their distributive shares. Any partnership whose owners hold a limited interest on paper and run the business in practice now faces a second appeals court reading the exception narrowly.

The case is Soroban Capital Partners LP v. Commissioner, and the court is the U.S. Court of Appeals for the Second Circuit. Florida is not in that circuit, so the ruling does not bind a Florida partnership. It still matters here, and this article explains why.

What the limited partner self-employment tax exception says

Partners pay self-employment tax on their share of partnership profit. Section 1402(a) of the Internal Revenue Code defines net earnings from self-employment. The definition includes a partner's distributive share of income or loss from a trade or business carried on by a partnership.

The rate is 15.3 percent, according to the IRS. That is 12.4 percent for Social Security and 2.9 percent for Medicare. The Social Security part stops at an annual cap. The Medicare part has no cap, and higher earners owe an extra 0.9 percent above the IRS thresholds. Tax professionals often call this SECA tax.

Paragraph (13) of that subsection is the exception at issue. It excludes the distributive share of any item of income or loss of a limited partner, as such, other than guaranteed payments for services actually rendered. The code never defines the words "limited partner." That silence is what both appeals courts had to fill in this year.

Guaranteed payments stay in the self-employment base either way. A guaranteed payment is compensation for services or the use of capital, fixed without regard to partnership income, under section 707(c). The fight is over the distributive share.

What the Second Circuit decided in Soroban Capital Partners

Soroban Capital Partners LP is a Delaware limited partnership that manages a group of hedge funds. The opinion says the firm earned some $247 million from investment management services in 2016 and 2017. Its three founding principals were limited partners of the firm and members of its general partner.

During those years, one principal was Managing Partner and Chief Investment Officer, one was Co-Managing Partner, and one was Head of Trading and Risk Management. The opinion says they worked full time, roughly 2,300 to 2,500 hours a year. They sat on all four governing committees in 2016 and all but one in 2017. They took part in decisions to hire, fire, promote, terminate, and evaluate employees.

For their services, the three received guaranteed payments of about $2.5 million across both years. Their distributive shares came to roughly $141.5 million. The opinion notes that is over 55 times the guaranteed payments. Soroban reported the guaranteed payments and the general partner's share as net earnings from self-employment, then excluded the $141.5 million.

The IRS issued notices of final partnership administrative adjustment in April 2022. The Tax Court sided with the IRS twice, first on the legal test in 2023 and then on the facts in 2025. The Second Circuit affirmed both decisions, and held that the Tax Court had jurisdiction to decide the adjustments.

The test, in the court's words. The panel gave section 1402(a)(13) a definition. A limited partner is "one who has limited liability and who does not run, manage, or otherwise exert control or managerial authority over the partnership." The court read the term as it was ordinarily used in 1977, the year Congress wrote the provision.

The caution in the footnote. The opinion says limited liability and lack of managerial control are the main characteristics of a limited partner. It adds that other limitations may vary state by state.

The line for partners who do some work. The court said a partner may play a role in the partnership and still qualify as limited. That holds so long as the activities do not amount to controlling, managing, or running the business. It noted the Commissioner takes the same position.

The Fifth Circuit landed in a similar place in August

On August 12 the Fifth Circuit issued a substituted opinion in K Alain, L.L.L.P. v. Commissioner, docket number 24-60240. The panel denied rehearing en banc, granted panel rehearing, and withdrew its January 16 opinion in the same case, then styled Sirius Solutions, L.L.L.P.

The new holding is that the original public meaning of limited partner is "a partner who plays no significant role in managing or running a business." The court vacated and remanded so the Commissioner could consider whether the partners in the case fall within that meaning.

The Second Circuit addressed the overlap directly. It said it does not disagree that a limited partner may provide some services to the partnership, and that the Commissioner does not disagree either.

Does the ruling bind a Florida partnership?

No. Under 28 U.S.C. 41, the Second Circuit's states are Connecticut, New York, and Vermont. The Fifth Circuit's states are Louisiana, Mississippi, and Texas. The Eleventh Circuit covers Alabama, Florida, and Georgia.

Where a partnership's Tax Court case goes on appeal is set by statute. Section 7482(b)(1)(E) sends a partnership petition under section 6234 to the court of appeals for the circuit holding the partnership's principal place of business. For a partnership based in Florida, that is the Eleventh Circuit. The Eleventh Circuit has not ruled on section 1402(a)(13), and the Soroban opinion does not mention it.

That is not the same as being in the clear. These cases are tried first in the Tax Court, and the Tax Court settled its own test in November 2023. It held that the exception does not apply to a partner who is limited in name only, and that a functional analysis decides the question. A Florida partnership that litigates this issue meets that test before any appeal.

Which Florida partnerships this question touches

Real estate funds and syndicators. The Real Estate Roundtable filed a friend-of-the-court brief supporting the taxpayers, as did the Managed Funds Association. The Tax Law Center at NYU Law filed on the government's side. Those filings show which industries believe the outcome touches them.

Management companies. A management company set up as a limited partnership, whose principals hold limited interests and run daily operations, has the structure both courts examined. The hours, the titles, the committee seats, and the hiring authority are the facts that mattered in Soroban.

Firms organized as limited partnerships. Both decided cases involve state-law limited partnerships, one a Delaware LP and one a limited liability limited partnership. Whether the same reading applies to members of a limited liability company is not what these two courts decided.

One boundary is easy to miss. Soroban covered 2016 and 2017, which fell under the TEFRA partnership audit rules. Later years are audited under the centralized regime that replaced TEFRA.

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Questions about the limited partner self-employment tax rules