On December 23, 2024, the Tax Court ruled in Denham Capital Management LP v. Commissioner (T.C. Memo. 2024-114)[1], that limited partners that actively participated in the activities of a fund manager formed as a state law limited partnership were subject to self-employment tax on all of their distributive share of income from the partnership. The Tax Court found that, consistent with its earlier ruling in Soroban Capital Partners LP v. Commissioner, 161 T.C. 310 (2023), limited partners of a state law limited partnership are not automatically entitled to the “limited partner exception” to self-employment tax under Section 1402(a)(13).[2] Rather, a functional analysis test must be applied to determine whether any state law limited partner should be considered a “limited partner, as such”[3] for purposes of the limited partner exception. The Tax Court applied the functional analysis test and found that each of the Denham limited partners’ activities, roles, and responsibilities rose to the level of those of an “active partner,” and therefore the limited partners did not qualify for the limited partner exception.

A similar case challenging the Soroban interpretation of the term “limited partner” in Section 1402(a)(13), Sirius Solutions LLLP v. Commissioner (Docket No. 30118-21), is pending in the Fifth Circuit Court of Appeals. In the meantime, however, the Denham and Soroban rulings have further entrenched the IRS’ position that a limited partner actively participating in a partnership will be subject to self-employment tax.

Our prior summary of Soroban is linked here.

[1] Denham Capital Management LP v. Commissioner (T.C. Memo. 2024-114)

[2] All Section references are to the Internal Revenue Code of 1986, as amended.

[3] Section 1402(a)(13) (which excludes from the definition of “self-employment income” the “distributive share of any item of income or loss of a limited partner, as such, other than guaranteed payments described in Section 707(c) to that partner for services actually rendered to or on behalf of the partnership to the extent that those payments are established to be in the nature of remuneration for those services. . .” (emphasis added)).