Article by Maury Cartine, Partner-in-Charge of Marcum’s National Alternative Investment Industry Group Tax Department, "Self-Employment Tax – Limited Partners Beware," Featured in All About Alpha
By Maury CartinePartner-in-Charge, National Alternative Investment, Tax Department
The IRS released Chief Counsel Memorandum CCA 201436049 on September 5, 2014 which provides guidance on the treatment of the exemption from self-employment tax under Section 1402(a)(13) of the Internal Revenue Code for a limited partner’s share of profits.
Section 1402(a)(13) exempts from self-employment tax a limited partner’s share of profits other than guaranteed payments for services described in Section 707(c) of the Internal Revenue Code. Since the date of enactment of then Section 1402(a)(12) [now Section 1402(a)(13)]on December 20, 1977 as part of P.L. 95-216, Social Security Amendments of 1977, 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 Section 1402(a)(13).
In 1997, the Treasury Department and the IRS promulgated proposed regulations defining limited partner for purposes of Section 1402(a)(13). Under these proposed regulations, a partner in a service partnership would not be treated as a limited partner under Section 1402(a)(13) and thus, a limited partner under state law 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 proposed regulations with respect to the definition of limited partner until July 1, 1998 under the Taxpayer Relief Act of 1997. The date of July 1, 1998 passed, but neither Congress nor the IRS took any further action.