Tax Court (Again) Rules that ’Limited Partners’ Providing Significant Services Cannot Avoid Self-Employment Tax

On May 28, 2025, the Tax Court ruled in Soroban Capital Partners, LP et al v. Commissioner (T.C. Memo 2025-52) that three individual “limited partners” of an investment management fund could not avoid having their distributive shares of the fund’s income sheltered from Self-Employment (SE) tax. The “Limited Partner exception” exempts limited partners, as such, from the SE tax and is found at section 1402(a)(13) of the Internal Revenue Code.  It is currently the subject of debate in several other ongoing legal proceedings.

Background on The “Limited Partner Exception”

Partners of partnerships generally are subject to SE tax on their distributive shares of partnership earnings from business operations. However, the Limited Partner exception excludes such earnings allocated to eligible partners from SE tax. Unfortunately, Congress did not define a Limited Partner for that purpose and has all but prevented the IRS from providing one through the issuance of regulations. So, the issue has been frequently litigated in the past couple of decades.

This is the second Tax Court decision affecting Soroban Capital Partners in the past year and a half (see our previous article on the first Tax Court decision affecting Soroban). On Nov. 28, 2023, the full Tax Court first ruled against Soroban in finding that while one may have the title of “limited partner” for state law purposes, the state law designation does not control for federal tax purposes (e.g., the exception to SE tax). The Tax Court further ruled that a “functional analysis test” was required to ascertain one’s status as a limited partner. Additional fact-finding was then ordered to apply that test to Soroban, culminating in the Tax Court’s separate decision that was just issued.

Shortly before the Tax Court’s second decision in Soroban, the Tax Court considered this test in separate legal proceedings involving a different taxpayer. In Denham Capital Management LP v. Commissioner (T.C. Memo 2024-114), the “functional analysis test” was performed to examine the relationship between the limited partner and the partnership to ascertain whether the limited partner is generally akin to a passive investor. In ruling against the taxpayer in Denham, certain factors were identified by the Tax Court as being relevant to the test. Armed with this additional precedent, the Tax Court in Soroban analyzed many of those same factors to apply the test to Soroban.

Soroban II

During the years in question, Soroban earned its income from managing its clients’ investments and earning investment management fees for doing so. In performing the functional analysis test, the Tax Court analyzed the following factors between the partnership and its limited partners:

• Sources of income and the partner’s roles in generating that income
• Relationship between distributive shares of income and any capital contributions made by the partners
• Extent to which the partners’ time, skills, and judgment were essential to the partnership’s income
• Roles that the partners played in the business, e.g, whether they served as employees, sat on committees, possessed the authority to bind the partnership, or took part in personnel decisions
• Time devoted to the business
• How the partnership advertised itself to the public, and whether it advertised any specific skills or expertise of the partners

Based on the analysis performed, the Tax Court concluded that the three individuals were limited partners “in name only,” and could not avail themselves of the exception from SE tax. The Court found that their activities were so intertwined with the success of the business that they were not functioning as mere passive investors.

Final Thoughts on Limited Partners Landscape

This is at least the sixth Tax Court decision involving limited partners and the exception to SE tax found in section 1402(a)(13), dating back to the Tax Court’s seminal 2011 decision in Renkemeyer, Campbell & Weaver, LLP v. Commissioner (136 T.C. 137).  In all but one case, the IRS has prevailed in that forum on this issue.

However, the Tax Court is not the final arbiter on who is and is not a limited partner in the context of section 1402(a)(13). Presently, two litigants in previous Tax Court cases (Denham Capital Management, LP and Sirius Solutions, LLLP) have appealed their Tax Court losses to the First and Fifth Circuit Courts of Appeal, respectively. Presumably, if Soroban wants to appeal its latest Tax Court defeat, it will go to the Second Circuit Court of Appeals. If one, two or all three Appellate Courts overturn the Tax Court, the scales could shift in favor of taxpayers.

Conceivably, the Supreme Court could also be called upon to opine on the issue, especially if there are conflicting decisions in the Circuit Courts. Alternatively, Congress may provide us with a definition of “Limited Partner” for purposes of the Limited Partner exception; however, there is no such language in the bill currently being debated.

We will continue to monitor the developments involving the other ongoing legal proceedings involving this topic. Should you have any questions on how the latest decision in Soroban affects you or your business, please connect with us.