Do You Have Limited Partners With NESE?

[BobKamman]

NESE, of course, is Net Earnings from Self Employment. If you prepare “limited partnership" returns, or income tax returns for “limited” partners receiving Schedules K-1, you have probably come up against the question of whether their share of business income is subject to SE tax. This week, the Tax Court in a memorandum opinion (you can look it up, Denham Capital Management) reviewed the court decisions on which IRS relied to assess SE tax on five partners in two years for something like a combined $50 million of income (so, mostly just the Medicare tax portion). Here is an excerpt from Chief Judge Kerrigan’s opinion:

Functional Analysis Test

Section 1401 imposes a tax on every individual’s self-employment income for a taxable year. § 1401(a) and (b). With minor exceptions not relevant here, self-employment income is equivalent to the NESE derived by an individual during the taxable year. § 1402(b). Section 1402(a)(13) excludes from NESE an individual’s 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 the extent the payments are in the nature of remuneration of services actually rendered to or on behalf of the partnership. We construe exceptions to NESE narrowly to achieve the congressional policy that the optimum number of potentially eligible persons will be provided for under the Social Security framework. Stevenson v. Commissioner, T.C. Memo. 1989-357, 57 T.C.M. (CCH) 1032, 1034 (citing Johnson v. Commissioner, 60 T.C. 829, 833 (1973)).

In Soroban, 161 T.C. at 320-31, the Court held “that the limited partner exception does not apply to a partner who is limited in name only” and that “Congress intended section 1402(a)(13) to apply to partners that are passive investors.” Before Soroban, in Renkemeyer, Campbell & Weaver, LLP v. Commissioner, 136 T.C. 137 (2011), the Court applied a functional analysis test to determine whether the lawyer-partners of a Kansas limited liability partnership were limited partners under section 1402(a)(13).

[sjrcpa]

Did this surprise you Bob?

I've always followed that reasoning.

[BobKamman]

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@sjrcpa wrote:

Did this surprise you Bob?

I've always followed that reasoning.

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No, it didn't surprise me, I just haven't been able to find good sources when the question is asked.  Because you need to rely on Tax Court opinions, there isn't much anywhere else.