SECA Limited Partner Exception: Ripe For Review?

The debate over the scope of the limited partner exception to the Self-Employment Contributions Act (“SECA”) continues to make its way through the courts.

Section 1402(a)(13) generally exempts the distributive share of partnership income allocable to a “limited partner, as such” from self-employment tax, but neither the statute nor the legislative history defines the term “limited partner.” Recent litigation has centered on whether the exception turns on a partner’s status under state law or, as the government contends, on a “functional analysis” of whether the partner acts as a passive investor.

In our last update, available here, we discussed the Fifth Circuit’s decision in Sirius Solutions LLLP v. Commissioner, which rejected the Tax Court’s functional analysis approach and held that a partner’s status as a limited partner under state law was sufficient to qualify for the exception. The decision stands in contrast to the Tax Court’s approach in Soroban Capital Partners LP v. Commissioner and Denham Capital Management LP v. Commissioner, discussed here and here, which applied a functional analysis to determine whether the partners functioned more as active service providers than as passive investors, creating the potential for a circuit split.

Since then, the litigation has continued to move through the appellate courts. In Soroban, briefing is complete and oral argument before the Second Circuit is scheduled for June 25. The taxpayers in Denham filed a reply brief in the First Circuit in May following supplemental briefing requested by the court. Taxpayers are now awaiting decisions that could either reinforce or further complicate the emerging disagreement over the meaning of “limited partner, as such.” If either court declines to follow the Fifth Circuit’s taxpayer-friendly state law approach in Sirius, the resulting circuit split could increase the likelihood of eventual Supreme Court review of one of the most closely watched and actively litigated issues in partnership taxation.