IRS Chief Counsel (CCA 201436049) has concluded that so-called limited partners of an investment management firm were not limited partners of the firm (a limited liability company (LLC) treated as a partnership) and were being paid compensation for services. Therefore, the amounts they received from the firm were subject to self-employment taxes under Code Sec. 1402(a)(13).
Code Sec. 1402(a)(13) excludes from self-employment income a limited partner’s distributive share of partnership income. Although the IRS issued proposed regs in 1997 that defined a limited partner, it never issued final regs. The 2014–2015 IRS Priority Guidance Plan includes a project to address the application of Code Sec. 1402(a)(13) to limited liability companies.
The management firm serves as the investment manager for a family of investment funds set up as limited partnerships. Most investors are passive limited partners under state law. Limited partners do not take part in the conduct of the fund they invest in. The management firm is a general partner of each fund and has full authority to manage each fund, including its investment activities.
Partners and employees of the firm provide management services to the funds. The firm receive fees for its services, based upon the fund’s assets. For the years under audit, the firm’s gross receipts and business income were derived entirely from management fees received for providing services to the funds. The firm did not receive any distributive shares from the funds.
Each partner of the firm worked for it full time, providing a range of investment-related services. Each partner receives a distributive share of the firm’s income, including the ordinary income attributable to management fees. The share is based on the units (interests) in the firm held by the partner.
Each partner receives a Form W-2 from the firm, which claimed that the wages paid were reasonable compensation. The firm treated all of its partners as limited partners with respect to their distributive shares.
Code Secs. 1401 and 1402 impose Social Security taxes on an individual’s net earnings from self-employment, defined as the gross income derived by the individual from any trade or business he or she carries on. Code Sec. 1402(a)(13) excludes from self-employment taxes the distributive share of income of a limited partner from the trade or business of a limited partnership, other than certain guaranteed payments that are compensation for services. In the legislative history for Code Sec. 1402(a)(13), Congress stated that the provision excludes from Social Security coverage certain earnings that are basically of an investment nature.
Chief Counsel Analysis
In Renkemeyer, Campbell, and Weaver LLP, the Tax Court determined that practicing lawyers in a law firm organized as a limited liability partnership were not limited partners and were subject to self-employment taxes. The court indicated that a limited partner’s interest is akin to that of a passive investor. Congress, in Code Sec. 1402(a)(13), did not intend to exclude partners from self-employment tax if they performed services for a partnership in their capacity as partners (acting in the manner of self-employed persons).
Chief Counsel rejected the partners’ claims that they were limited partners and were not self-employed. The partners provide extensive services to the firm as partners, and the firm derives its income from the services provided by the partners. This income is not income of an investment nature that should be excluded from self-employment tax. Like Renkemeyer, the partners’ earnings are a direct result of their services.
In Rev. Rul. 69-184, the IRS stated that a partner who devotes his time to the conduct of the partnership’s business, or who provides services to the partnership, is a self-employed individual rather than an employee. The IRS concluded that the firm cannot change the character of the partners’ distributive shares by claiming that the partners are separately being paid wages and that the distributive shares are not compensatory.