United States

Investment management partners not exempt from self-employment tax


On Sept. 5, 2014, the IRS Office of Chief Counsel released chief counsel advice memorandum 201436049 (CCA 201436049), addressing whether partners of a fund management company can be treated as limited partners for purposes of the self-employment tax exclusion of section 1402(a)(13) when those partners perform extensive services for the management company.

Under the facts of CCA 201436049, a management company acts as the investment manager for a managed fund that conducts its investment activity through two limited partnerships. The management company also holds a general partnership interest in each of the two limited partnerships. The management company has full authority and responsibility to manage and control the business of each of the funds. For the years at issue, the fund management company's gross receipts and net ordinary business income were entirely attributable to management fees the company earned through providing services to the funds.

Organized as a limited liability company and treated as a partnership for federal tax purposes, the management company is comprised of individual partners who perform a variety of personal services either directly for the managed funds (on behalf of the management company) or as operational support for the management company itself. For the years at issue, the management company treated all partners as limited partners who were not subject to self-employment tax on their distributive shares.1

Generally, partners must include their distributive share of partnership income when calculating net earnings from self-employment and the associated self-employment tax liability. Section 1402(a) defines "net earnings from self-employment" as the gross income an individual receives from any trade or business plus the individual's distributive share of income or loss from a partnership in which he or she is a partner, unless a specific exclusion applies. Section 1402(a)(13) generally provides that the distributive share of partnership income or loss is excluded from the net earnings from self-employment if the partner receiving the distribution is a limited partner.

To determine whether the management company's partners are limited partners for the purposes of the limited partner exclusion of section 1402(a)(13), the IRS first looked to the legislative intent of the provision. The IRS determined that the legislative history "clarifies that Congress did not intend to allow service partners in a service partnership acting in the manner of self-employed persons to avoid paying self-employment tax." Although the code does not specifically define limited partner for purposes of the section 1402(a)(13) exclusion, the IRS analyzed case law2 to determine that income earned by limited partners is generally in the form of a return on investment and not compensation for active participation in the partnership's business operations.

In this case, the IRS found that the partners of the management company perform "extensive investment and operational management services for the partnership in their capacity as partners," and that the management company's income consists entirely of fees for services that are included in the partner's distributive shares under section 702(a)(8). Furthermore, because the income earned by the partners was not merely of an investment nature, the IRS concluded the partners are not limited partners for purposes of the exclusion under section 1402(a)(13).

Future implications

The IRS holding in CCA 201436049 evidences its desire to restrict the scope of the limited partner exemption in section 1402(a)(13), particularly where the entity is providing services to its clients or customers and the partners are providing services to or on behalf of the entity. The IRS relied on recent judicial decisions that have focused on legislative history suggesting that the exemption was originally intended to apply only to income representing a return on a partner's capital, although the statutory language may suggest otherwise. On a positive note, the IRS apparently had no problem extending the limited partner exemption to members of an LLC where the partners' income could be shown to represent a return on capital and not compensation for personal services. A CCA carries no precedential value, and this particular CCA does not break any new ground in its analysis. Nevertheless, it serves as a reminder that care should be taken in applying the limited partner exemption to situations where the entity is receiving fees for services provided to its clients or customers, the entity's partners are providing services to or on behalf of the entity with relatively little capital at risk, or both–as was true in this case. 

1 Guaranteed payments representing health insurance premiums and parking benefits paid by the management company were reported as subject to the self-employment tax.

2 Renkemeyer, Campbell, and Weaver LLP v. Commissioner, 136 T.C. 137 (2011); Riether v. United States, 919 F. Supp. 2d 1140 (D. N.M. 2012).


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