Key IRS Cases Challenge Limited Partner Tax Exemptions 2024

The Tax Court’s initial decision in Soroban v. Commissioner put asset management firms and the tax professionals working with them on alert last year. While that decision is subject to ongoing deliberations and is expected to be appealed, two other cases concerning the limited partner exception to self-employment tax under Section 1402(a)(13) are continuing to work their way through the courts.

In Denham Capital Management LP v. Commissioner, the IRS argues that the Tax Court’s initial ruling in Soroban Capital Partners LP v. Commissioner was correct in requiring a functional analysis to determine limited partner status. Denham, a Boston-based private equity firm, contends that the Soroban decision was flawed and is pushing for a reversal, asserting that the Denham partners should be considered limited based on state law alone. Denham, in its post-trial briefs, points to the legislative history of Section 1402(a)(13) as well as the parallel definition of net earnings from self-employment in the Social Security Act and Internal Revenue Code. Denham argues that such self-employment income should not be excluded under the Social Security Act, thereby preventing limited partners from earning Social Security benefits while being included under the Internal Revenue Code, leading to the payment of self-employment taxes. Additionally, Denham raises an argument that the Soroban decision by the Tax Court was flawed and created a vague and unworkable functional test. Further, Denham argues that the Tax Court is not bound to the same conclusion reached in Soroban, echoing a procedural rule that was recently employed by the Supreme Court in Loper Bright Enterprises Inc. v. Raimondo, where the Supreme Court referenced earlier case law in concluding that stare decisis is not an “inexorable command.”

Similarly, in Sirius Solutions LLLP v. Commissioner, a Texas consulting firm is appealing its settlement with the IRS in an earlier Tax Court decision, which held that the Soroban ruling controls its own case. Sirius decided to settle with the IRS in the Tax Court after the Soroban decision but is now appealing that holding to the Fifth Circuit. The taxpayer is arguing that the limited partner exception was intended to reference state law in validating limited partner status — without the need for a separate functional test — and raises similar arguments as those made in the Denham Tax Court proceedings.

Both cases highlight ongoing disputes over the interpretation of Section 1402(a)(13), with significant implications for the taxation of limited partners. These developments are crucial for firms organized as state law limited partnerships, as these cases could affect limited partners’ tax liabilities under the Self-Employment Contributions Act (SECA). These developments are not expected to be relevant for firms organized as limited liability companies or limited liability partnerships.

For guidance or more information, connect with one of our CBIZ tax professionals today. We will continue to keep you informed as these cases progress.