September 18, 2014
Self-Employment Tax - Limited Partners Beware!
By Maury Cartine, Partner, Alternative Investments
The IRS released a Chief Counsel Memorandum on September 5, 2014 which provides guidance on the treatment of the exemption from self-employment tax for a limited partner's share of profits.
The Internal Revenue Code exempts from self-employment tax a limited partner’s share of profits, other than guaranteed payments, for specific services described within the Code. Tax professionals have generally treated a limited partner's share of profits, other than guaranteed payments, as exempt from self-employment tax even when the limited partner had no significant capital at risk. Consequently, limited partners in service businesses paid self-employment tax only on guaranteed payments. Tax professionals were somewhat less aggressive with members of limited liability companies since it was never clear that a member of a limited liability company was a "limited partner" for purposes of the Code.
Previous proposed regulations, dating back to 1997, indicated that a limited partner in a service partnership would not be permitted to exclude his or her share of profits of a service partnership from self-employment tax. These proposed regulations ignited controversy and, as a result, Congress precluded the Treasury Department from issuing any other proposed regulations with respect to the definition of limited partner for a specified period of time. Thereafter, neither Congress nor the IRS took any further action.
In 2011, the United States Tax Court took action to fill the gaping hole left by the legislative and administrative branches of our Government. In the case, Renkemeyer, Campbell & Weaver, LLP et. al. v. Commissioner, the Court concluded that a service partner's share of profits was never intended to be excluded from self-employment tax by Congress. Citing a House Report, the Court concluded that only a limited partner's share of profits attributable to the partner's investment in the partnership was intended to be excluded from the self-employment tax.
The Chief Counsel Memorandum concludes, similar to the Court in Renkemeyer v. Commissioner, a limited partner's share of profits that are not attributable to a return on a capital investment should be subject to self-employment tax. It is interesting to note that both the United States Tax Court and the Chief Counsel were careful to distinguish limited partners of a limited partnership from partners in a limited liability partnership or members of a limited liability company. Notwithstanding the apparent reliance by both the Court and the IRS on the intent of Congress, both the Court and the IRS seem to take additional comfort in distinguishing limited partners from members in other types of entities treated as partnerships for federal income tax purposes.
It is now clear that the exclusion of a limited partner's share of profits in a service partnership from self-employment tax is under a formidable attack. Partners of limited liability partnerships and members of limited liability companies face even more dire straits since they apparently will not be regarded as "limited partners."
Limited partners should continue to be concerned about the impact of the decision in Renkemeyer v. Commissioner. Following that decision, Marcum LLP suggested that limited liability companies convert to limited partnerships if the members wanted to avail themselves of the exclusion from self-employment tax. This still seems to be good advice. However, risks remain even for limited partners. The issue may ultimately be settled by a simple legal analysis regarding the Court's reliance on Congressional intent in Renkemeyer v. Commissioner versus the clear and unambiguous language of the Code. This matter is far from over, but members in service partnerships should give themselves the best chance for successful exclusion of profits from self-employment tax by making sure they qualify as "limited partners."
For more information, Contact your Marcum Tax Advisor or see the following authorities:
- Chief Counsel Memorandum CCA 201436049, 9/5/2014
- Section 1402(a)(13) of the Internal Revenue Code
- Section 707(c) of the Internal Revenue Code
- Public Law 95-216, Social Security Amendments of 1997
- House Report 95-702 for P.L. 95-216
- Renkemeyer, Campbell & Weaver, LLP et.al. v. Commissioner, 136 T.C. 137 (2011)