Tax Court applies limited partner functional test for self-employment income

Editor: Michael J. Mondelli, J.D.

The Tax Court analyzed the day–to–day functions of a state–law limited partnership’s limited partners, including their roles in generating income and management, their time devoted to the business, and their capital contributions. Based on its analysis, the court found that the limited partners were limited partners in name only. Therefore, their distributive shares of the partnership’s ordinary income were held to be net earnings from self–employment and subject to self–employment tax (Soroban Capital Partners LP,T.C. Memo. 2025–52).

Background

Soroban Capital Partners LP is an investment firm organized as a limited partnership that had one general partner and three limited partners (Eric Mandelblatt, Guarav Kapadia, and Scott Friedman). For the tax years at issue (2016 and 2017), Soroban, when calculating its net earnings from self–employment, included guaranteed payments made to the limited partners but excluded their distributive shares of ordinary income.

In April 2022, the IRS sent Soroban notices of final partnership administrative adjustment for 2016 and 2017, adjusting its net earnings from self–employment by including the ordinary business income allocated to the limited partners. Soroban petitioned the Tax Court for a redetermination. On a motion for summary judgment, the court held that a functional analysis of the limited partners’ roles and responsibilities in subsequent proceedings would be required to determine the extent to which the Sec. 1402(a)(13) limited–partner exception applied (Soroban Capital Partners LP, 161 T.C. 310 (2023); see also Beavers, “Sec. 1402(a)(13) and Limited Partnerships,” 55–3 The Tax Adviser 62 (March 2024), and Zima, “Limited Partners and Self–Employment Tax: A New Test,” 55–5 The Tax Adviser 38 (May 2024)).

Partnerships are required to include in their calculation of net earnings from self–employment their partners’ distributive shares of ordinary income. However, the limited–partner exception of Sec. 1402(a) excludes from net earnings from self–employment the distributive share of any item of income or loss of “a limited partner, as such,” other than guaranteed payments, for services actually rendered to or on behalf of the partnership that are in the nature of remuneration for those services.

To determine whether the limited partners qualified as limited partners for purposes of Sec. 1402(a)(13), the court subsequently applied a functional analysis into their roles and responsibilities.

Application of the functional analysis

The Tax Court noted that it had applied a functional analysis in a factually analogous case, Denham Capital Management, LP, T.C. Memo. 2024–114. In that case, the court found that the test is designed to be a comprehensive inquiry into whether the limited partners “were ‘generally akin’ to passive investors” (quoting Renkemeyer, Campbell & Weaver, LLP, 136 T.C. 137, 147—48 (2011)). Under this test, to exclude a limited partner’s distributive share of partnership income from net earnings from self–employment, the surrounding circumstances of the limited partner’s economic relationship with the limited partnership must sufficiently indicate that it is generally one of passive investment.

In Renkemeyer, the Tax Court had concluded that the intent of Congress “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 toward Social Security coverage.” The court stated further in Renkemeyer that “the legislative history … does not support a holding that Congress contemplated excluding partners who performed services for a partnership in their capacity as partners (i.e., acting in a manner of self–employed persons) from liability for self–employment taxes” (citing H. Conf. Rep’t No. 95–702, 95th Cong. (1977)).

Roles and responsibilities of the limited partners

Following its opinions in Renkemeyer and Denham, the Tax Court analyzed the partners’ roles and responsibilities. The court reviewed the sources of Soroban’s income for the years in issue, the limited partners’ roles in generating that income, and the relationship between the limited partners’ distributive shares and any capital contributions they made to the partnership.

Limited partners’ role in generating Soroban’s income: As the Tax Court noted, Soroban generated income from fees it charged its clients for managing investments. The court found that the limited partners’ time, skills, and judgment were essential to these services. This indicated that the limited partners were actively participating in the business.

Limited partners’ roles in Soroban’s business: Mandelblatt was Soroban’s managing partner and chief investment officer during the years in question. His duties included managing the investing of the portfolios of Soroban’s funds on its behalf. Soroban described him as responsible for “portfolio management,” “research,” and “risk management,” and that he had “final discretion on all portfolio–related matters.”

Kapadia was Soroban’s co–managing partner, with duties similar to Mandelblatt’s. Like Mandelblatt, Soroban described him as responsible for “portfolio management,” “research,” and “risk management.”

Friedman was Soroban’s head of trading and risk management. His duties included executing Mandelblatt’s and Kapadia’s investing decisions. Soroban described him as responsible for Soroban’s “risk management” and “trade execution.”

Each individual served on all the committees that oversaw Soroban’s operations. Soroban had a number of other employees, including a COO, CFO, head of investor relations, general counsel, and chief compliance officer. The limited partners, as principals, exercised control over the daily operation of the business, including hiring and firing.

Based on the roles the limited partners played in Soroban’s business, the court found that they actively participated in the management of the business.

Relationship between the limited partners’ distributive shares and capital contributions: Kapadia and Friedman had not made any capital contributions to Soroban, and Mandleblatt’s capital contributions were disproportionately low compared to the distributions he received. Thus, the Tax Court found that the limited partners’ capital contributions were insignificant, which showed that their distributive shares of income were not returns on investment.

The Tax Court’s holding

The Tax Court concluded that its functional analysis showed that Soroban’s limited partners were limited partners in name only. The court pointed out that during the years in issue, Soroban earned income from managing investments. The limited partners played an essential role in generating this income. Soroban acknowledged that the limited partners’ unique skills and experience were indispensable to the business. They exercised managerial control over Soroban and worked full time with it. They contributed little to no capital relative to their shares of income, making it clear that their earnings were not of an investment nature. Thus, the court held they were not limited partners within the meaning of Sec. 1402(a)(13), and their earnings constituted net earnings from self–employment for the years at issue.

Editor

Michael J. Mondelli, J.D., is a director in the Tax Advisory Group, with SingerLewak LLP in Irvine, Calif.

For additional information about these items, contact Mondelli at mmondelli@singerlewak.com.

Contributors are members of or associated with SingerLewak LLP.