Partnership Profits May Be Subject to Self-Employment Tax, Even If You are a “Limited Partner”
What Was the Issue?
Under federal tax law, partners who are truly passive, meaning they do not participate in running the business, are generally not required to pay self-employment tax on their share of profits.
But in this case, the IRS argued, and the Tax Court agreed, that several “limited partners” at Denham Capital were actively managing aspects of the business. As a result, their income was subject to self-employment tax under IRC § 1402(a)(13).
What Did the Court Say?
The Court didn’t just look at titles—it focused on what the partners actually did.
In its findings, the Tax Court determined that:
Partners Were Actively Involved: They sourced investments, managed portfolio companies, negotiated deals, and helped steer firm strategy.
They Served in Key Roles: Some partners served on investment and valuation committees and were compensated in part through performance-based incentives.
Labels Didn’t Matter: Even though these individuals were called “limited partners” in formal agreements, their real-world activities showed they were functionally general partners.
No Exemption Allowed: Because they materially participated, the Court held their share of income was subject to self-employment tax.
This Case Reaffirms Soroban Capital Partners LP
This was not a new or one-off decision. The Denham case reaffirmed the Court’s reasoning in an earlier case: Soroban Capital Partners LP v. Commissioner, 161 T.C. 310 (2023).
In Soroban, the Tax Court established that it’s not the legal title of “limited partner” that determines tax treatment, but the partner’s actual level of involvement in the business. If you materially participate, you do not qualify for the self-employment tax exclusion, even if state law or your partnership agreement says otherwise.
Are These Cases Being Appealed?
Yes. Denham Capital has already appealed its case to the First Circuit Court of Appeals. The outcome could affect how broadly the IRS applies these rules to partnerships and funds going forward.
As for Soroban, while the case has not yet been appealed, it is appealable to the Second Circuit, and legal commentators widely expect an appeal due to the stakes involved. If appeals in Denham, Soroban, and other pending cases like Sirius Solutions (See The Sirius Solutions Case Could Redefine Self-Employment Tax Rules for Partnerships) move forward in different federal circuits, it could potentially create a circuit split which might push this issue closer to the Supreme Court.
Why This Matters to You
A Title Doesn’t Guarantee Tax Protection
Being called a “limited partner” doesn’t automatically exempt you from self-employment tax. The IRS and courts will look at what you actually do.
Involvement Means Tax Liability
If you help manage the business, make decisions, or oversee teams, even part-time, you may owe self-employment tax on your income.
Your Business Structure May Be Outdated
Many business owners and fund managers are now revisiting how their partnerships and LLCs are structured and how their roles are defined to avoid unexpected tax bills.
What Should You Do Now?
If you’re a general partner, managing member, fund principal, or even a “limited partner” involved in business decisions, you should:
Assess Your Role — Are you hands-on, or purely passive?
Review Your Partnership Agreement — Does it reflect economic reality?
Evaluate Your SE Tax Exposure — Especially if you are in a fund, family office, or consulting entity.
Want Peace of Mind?
I help business owners and investors identify tax risks hidden inside partnership structures—and help align legal documents with economic reality to reduce audit risk.
Contact me today for a confidential partnership review to discuss how these developments may affect your current tax position and what steps you can take to stay ahead of potential changes.