I noticed an interesting case from the Tenth Circuit which found that a two to three percent working interest in an oil and gas venture could generate self-employment income for the owner of that interest. The individual in question entered into both a purchase agreement and an operating agreement with the operator of the oil and gas venture. The operator designated the income as non-employee compensation and did not send a Schedule K-1. The individual paid federal income taxes on the income but did not pay self-employment taxes. The tax court determined that the individual’s arrangements with the operator constituted a partnership under the Internal Revenue Code and concluded that the individual should have paid self-employment taxes on that income. The Tenth Circuit upheld the decision of the tax court, rejecting the individual’s argument that he was a passive investor and therefore not responsible for self-employment income. The court determined that the existence of a partnership is a question of fact and looked at the rights that the individual had in the oil and gas venture, including rights to

  • Inspect receipts, vouchers, insurance policies, legal opinions, logs, reports, tests, and other records,
  • Audit the books and records,
  • Enter the property to inspect operations,
  • Obtain information reasonably requested regarding development and operation, and
  • Inspect the operator’s records.

The individual shared rights and costs in proportion to the share of the working interest.

I am not an oil and gas attorney but I would not be surprised if the rights that this individual held are typical of the industry and not often exercised by those who hold a two to three percent working interest. Nevertheless, they were sufficient for the tax court and the Tenth Circuit to find a partnership existed that generated self-employment income.

So what is the connection to multiemployer pension plan withdrawal liability about which I have written frequently? Withdrawal liability is imposed on employers who withdraw from multiemployer plans that are underfunded. If one of these oil and gas entities participates in a multiemployer pension plan and withdraws, all partners in the partnership would be responsible to pay the withdrawal liability if the employer does not itself make the payment. In other words, if the oil and gas venture becomes insolvent and does not pay, the plan is likely to look to the partners for payment. Unless such individuals can show that they are limited partners for federal tax purposes and not general partners, they are likely to be held personally responsible for the withdrawal liability. The conclusion that the individual is subject to self-employment income suggests that the individual is not a limited partner, but is more akin to an active investor.

I may be reading too much into this case; however, as multiemployer plans look more aggressively for solvent payers of unpaid withdrawal liability, individuals in the position of this oil and gas venturers may find themselves swept into the group of parties responsible for withdrawal liability.