For the most part, the income received by a limited partner from a limited partnership is not subject to the self-employment tax. There is an exception if a limited partner receives a guaranteed payment for providing services to the partnership. A guaranteed payment is similar to a fixed salary, payable whether or not the partnership has any profits. A member of a limited liability company is treated as a limited partner unless he or she is actively involved in running the business of the company. In Chief Counsel Advice 20160014, the IRS Chief Counsel’s office addressed what appeared to be a blatant attempt to perform an end run around these rules.
The taxpayer was a franchisee of many restaurant locations operated by a limited liability company. The only members of the company were the taxpayer, his wife, and a trust. The taxpayer spent all his time working in the business and made all of the key decisions for the business. He received a small guaranteed payment that he reported as being subject to the self-employment tax. The rest of his substantial income from the restaurants flowed through to him as partnership income on Form K-1. He took the position that he was a limited partner and therefore this income was not subject to self-employment tax.
The Chief Counsel’s office determined that all of his income from the company was subject to self-employment tax. It cited as legal authority the Renkenmeyer case, where law firm partners who practice law full time were limited partners in their law partnership. The Tax Court in that case determined that the term “limited partner” for purposes of the self-employment tax was intended to be restricted to persons in the nature of passive investors, not those actively involved in the day-to-day operations of the business.