The Tax Court has reopened the question of whether limited partners are entitled to an exemption from self-employment taxes—an issue that's been in hibernation for over 13 years. The February 9 opinion in Renkemeyer v. Commissioner, 136 T.C. No. 7(2011) concludes that status as a limited partner does not necessarily exempt a partner from self-employment taxes; the exemption depends on the partner's level of participation in partnership business.
The Tax Code says that limited partners don't have to pay self-employment tax. That sounds simple enough, but the Code doesn't define "limited partner," leaving the term open for interpretation. As a result, business owners with wildly divergent roles in their businesses have claimed limited partner status and the exemption from self-employment taxes that comes with it.
The IRS isn't inclined to allow everyone who claims limited partner status to avoid self-employment taxes and frequently disputes those claims.
Who is entitled to claim the exemption?
There are two primary types of limited partnerships, both creatures of state law. The limited partnership (LP) has both general and limited partners and the limited liability partnership (LLP) has only limited partners.
Generally, limited partners in an LP do not actively participate in partnership business—they often provide capital in exchange for a partnership interest. Those limited partners are akin to the traditional concept of the silent partner. In contrast, limited partners in an LLP may actively participate in partnership business. They are "limited" in the sense that they have limited liability for the firm's debts.
The question in Renkemeyer was whether limited partners in a LLP are entitled to an exemption from self-employment taxes. Renkemeyer was an attorney for a limited liability partnership engaged in the practice of law. In 2004, approximately 99% of the firm's income was derived from legal work performed by the firm's attorneys—in other words, the firm's owners actively worked in the business.
When Renkemeyer received 36% of the firm's net income in 2005, he argued that his interest in the partnership should fall under the exemption from self-employment taxes.
Judge Julian Jacobs, who presided over the case, disagreed with Renkemeyer. He held that merely labeling oneself as a limited partner was insufficient to qualify for the exemption, and that the test for exemption should be whether the individual actively participates in the business. Thus, because Renkemeyer actively worked as an attorney for the LLP, he was not entitled to the exemption from self-employment taxes.
