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In brief

In the recent case of Soroban Capital Partners LP v. Commissioner, 161 T.C. No. 12 (2023), the Tax Court held that the limited partner exception under section 1402(a)(13) does not apply to limited partners who the Court concluded were not limited partners “as such”; thus certain “limited partners” of a partnership may be subject to Self-Employed Contributions Act tax. The Tax Court in Soroban held that determining a “limited partner” for section 1402(a)(13) purposes requires a factual inquiry into the functions and roles carried out by such limited partner. If the factual inquiry shows that a limited partner is heavily involved in the partnership’s business and/or performed services for the partnership, such limited partner’s distributive share may be subject to Self-Employed Contributions Act tax.


  1. Background
  2. Soroban Capital Partners
  3. The decision
  4. What now?


Social Security tax, as we commonly know it, is divided into two systems. First are the Federal Contributions Act (FICA) taxes imposed on employers and employees under sections 3101-3128. Second is the Self-Employed Contributions Act (SECA) tax imposed on self-employed individuals under sections 1401-1403. Most Americans pay, and are familiar with, FICA tax because they work as an employee rather than being self-employed.

For those self-employed individuals, SECA tax requires them to contribute to Social Security (12.4%) and Medicare (2.9%) by taxing their net earnings from self-employment. SECA tax is imposed on an individual who earns “self-employment income,” which is defined in section 1402(b) as “net earnings from self-employment derived by an individual … during any taxable year”. The term “net earnings from self-employment” (NESE) is defined in section 1402(a) to include:

Gross income derived by an individual from any trade or business carried on by such individual, less the deductions allowed by this subtitle which are attributable to such trade or business, plus his distributive share (whether or not distributed) of income or loss described in section 702(a)(8) from any trade or business carried on by a partnership of which he is a member.

However, a very meaningful exception under section 1402(a)(13) provides that NESE does not include “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)” (“Limited Partner Exception”). This counterintuitive exception, enacted in 1977, was originally intended as an anti-abuse rule. Social Security was meant to replace lost earnings from work and Congress wanted to prohibit Social Security fundings/benefits from passive investment earnings from limited partnerships.

Unfortunately, neither Congress nor the IRS has defined “limited partner” for purposes of section 1402(a)(13). The IRS attempted to do so twice: first in regulations issued in 1994 (which were withdrawn), then with proposed regulations in 1997. Under the 1997 proposed regulations, the IRS provided that a partner of any entity taxable as a partnership that afforded limited liability to its owners would qualify as a limited partner under section 1402(a)(13), provided that the member did not participate in the business of the entity for more than 500 hours per year. Prop. Reg. §1.1402(a)-2(h)(2) (1997). However, Congress enacted a law specifically preventing the finalization of regulations defining “limited partner” under section 1402(a)(13). See Taxpayer Relief Act of 1997, Pub. L. No. 105-34, §935. Although the injunction expired in 1998, Congress nor the IRS has defined the term “limited partner” since.

Soroban Capital Partners

Soroban Capital Partners LP (SCP) is a hedge fund organized as a Delaware limited partnership, classified as a partnership for US federal income tax purposes. SCP had one general partner and three limited partners analyzed by the Tax Court. Per SCP’s limited partnership agreement, the general partner had authority over the business affairs of the partnership. Many of the limited partners, however, had active roles and rights over the business. For example, one of its limited partners served as the managing partner and chief investment officer of SCP.

SCP listed its guaranteed payments and the general partner’s share of ordinary business income as subject to SECA tax. But it did not report the limited partners’ share of ordinary business income as subject to SECA tax. The IRS contended that such distributive share of ordinary business income should also be subject to SECA tax because the Limited Partner Exception did not apply. 

The decision

SCP filed a motion for summary judgement, arguing that it should satisfy the Limited Partner Exception of section 1402(a)(13) because its partners were limited partners in a state law limited partnership. The IRS disagreed, noting that limited partners in state law limited partnerships are not automatically exempt from SECA tax. Instead, the IRS argued that the Tax Court must apply a functional analysis test, similar to the test outlined in Renkemeyer, Campbell & Weaver, LLP v. Commissioner, 136 T.C. 137 (2011), to determine whether individuals are limited partners pursuant to section 1402(a)(13).

Accordingly, the Tax Court reviewed whether SCP’s limited partners were “limited partners, as such” as set forth in section 1402(a)(13) which, in turn, determines whether the SCP limited partners properly excluded their shares of ordinary business income from their NESE. The Tax Court ruled on several other issues, but our focus here is on section 1402(a)(13) only.

In Renkemeyer, partners of a law firm organized as a limited liability partnership (LLP) claimed to be exempt from SECA tax under section 1402(a)(13) because the organizational documents of the law firm classified their interests as “limited partnership interests” and the governing LLP statute under state law insulated them from liabilities of the law firm. The Tax Court in Renkemeyer disagreed. It first analyzed the legislative history of section 1402(a)(13) and concluded that its intent “was to ensure that individuals who merely invested in a partnership and who were not actively participating in the partnership’s business operations … would not receive credits towards Social Security coverage.” Renkemeyer, 136 T.C. at 150. Then, the Tax Court held that the LLP partners were not limited partners for purposes of section 1402(a)(13) because their “distributive shares arose from legal services … performed on behalf of the law firm” and not “as a return on the partners’ investments.” Id. In doing so, the Tax Court undertook a functional analysis of the roles of the partners to determine whether they were acting as limited partner investors or providing services to the partnership.

Following Renkemeyer, the Tax Court in Soroban denied SCP’s motion for summary judgment and held that the Limited Partner Exception does not apply to a partner who the court concluded were not limited partners, “as such.” The Tax Court held that a functional analysis test, as applied in Renkemeyer, is required to determine whether the Limited Partner Exception applies to the SCP limited partners. The Tax Court, however, did not undertake the analysis because this was a ruling on SCP’s motion for summary judgment.

What now?

As noted above, the Tax Court in Soroban has not yet addressed whether limited partners of SCP meet the functional analysis test, which will require further review of the facts and circumstances. We suspect this will resolve through further proceedings, including a potential trial. The facts of the case, however, appear to be a common arrangement for investment funds which makes the final result worth watching. As noted above, one of its limited partners served as the managing partner and chief investment officer of SCP. The others hold or held titles as “co-founder” and/or “co-managing partner” of SCP, suggesting day to day involvement in SCP’s business.

Given that many fund managers receive a periodic management fee equal to a fixed percentage of the investor capital commitments (generally 1.5 to 2%), the Soroban case is expected to have a profound impact on how fund managers and general partners are structured. Because of the lack of guidance, fund managers have diverged in their interpretation of section 1402(a)(13). Some take a position similar to SCP, relying on its state law limited partnership classification to claim that its limited partners are exempt from SECA tax. Others follow the 1997 proposed regulations as if they were effective. In light of Soroban, fund managers should review their tax positions under section 1402(a)(13), assess their risk exposure, and explore mitigation strategies. For example, fund managers following the 1997 proposed regulations may consider documenting their tax positions and the hours each limited partner participated in the business entity.

SECA tax was already an agenda for the IRS’s 2018 compliance campaign, so given its preliminary success under Soroban, we expect more IRS scrutiny in this area during audits. Despite its precedential value, however, taxpayers should note that Soroban is not the final word on the matter. Soroban could be overruled in appeal and there could be a circuit split on the matter given that the IRS is litigating the same issue in other circuit courts.

Finally, taxpayers should stay tuned for IRS guidance to be issued under section 1402(a)(13) in the near future. Guidance under section 1402(a)(13) was already a topic included in the IRS’s 2023-2024 Priority Guidance Plan, but the favorable ruling of Soroban may serve as the impetus for the IRS to complete its rule-making process before the 2024 presidential election.


Jason A. Graham is a partner in Baker McKenzie's Tax Practice Group in Dallas. He advises US and multinational corporations, partnerships, limited liability companies, and other pass-through entities on domestic and international tax planning and transactions.


Sukbae David Gong is an associate in Baker McKenzie’s Global Tax Practice Group in Chicago. He provides domestic and international tax planning advice for corporations and pass-through entities. Prior to law school, he was an auditor at a Big Four accounting firm working on financial statement audits of various public and private companies. He passed the CPA exam in 2009. He was also a sergeant in the Republic of Korea Army.

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