The United States Tax Court recently issued Renkemeyer, Campbell & Weaver, LLP v. Commissioner, 136 T.C. No. 7 (2011), an opinion which addressed the federal self employment tax liability of partners in a limited liability partnership ("LLP"). Although the case involved partners in an LLP, the Tax Court's analysis could be applied to a situation where a limited partner in a traditional limited partnership performs services for the partnership. This may be relevant for a private fund manager that has been established as a limited partnership, rather than a limited liability company ("LLC").
Applicable Statutory Provisions and Current Application to Private Fund Managers
Section 1401(a) of the Internal Revenue Code of 1986, as amended (the "Code"), imposes a tax on an individual's self employment income. Self-employment income includes, among other things, an individual's distributive share of income or loss from any trade or business carried on by a partnership of which he is a member. Code section 1402(a)(13) provides an exclusion from self employment income (the "Limited Partner Exclusion") for "the distributive share of any item of income or loss of a limited partner, as such, other than guaranteed payments described in Code section 707(c) to that partner for services actually rendered to or on behalf of the partnership to the extent that those payments are established to be in the nature of remuneration for those services."
Some private fund managers have organized their management vehicles as limited partnerships, and have relied upon the literal language of the Code to take the position that income earned in such limited partnerships allocable to the limited partners is not subject to the self employment tax. Members of management companies that have been organized as LLCs typically have paid the self employment tax on their allocable income.
Facts, Analysis and Potential Impact on Private Fund Managers
In Renkemeyer, the taxpayers were partners in a law firm organized as an LLP, a type of limited partnership structure that may only be established for professionals such as lawyers, doctors, etc. The taxpayers took the position that their interests in the law firm should be considered interests as limited partners that qualified for the Limited Partner Exclusion. The taxpayers asserted that their interests in the law firm shared characteristics of those of a limited partner in a limited partnership because their interests (a) were designated as limited partnership interests in the law firm's organizational documents, and (b) enjoyed limited liability pursuant to applicable state law.
The Tax Court noted that, in contrast to a traditional limited partnership, all partners of an LLP enjoy limited liability protection and may have management powers. Since the Limited Partner Exclusion does not provide a definition of "limited partner", the court reviewed the legislative history of the Limited Partner Exclusion for guidance. The court determined that the intent of the Limited Partner Exclusion 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 further stated that the legislative history of the Limited Partner Exclusion "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 the manner of self-employed persons), from liability for self-employment taxes." Since the partners' shares of the income arose from legal services they performed on behalf of the law firm, the court ruled that the Limited Partner Exclusion did not apply to the partners.
In the case of private fund managers that are established as limited partnerships, the owners of such limited partnerships are typically the management/operating personnel of the manager and, hence, could be viewed as performing services for and actively participating in the operations of the partnership. Based on the Renkemeyer case, it is possible that a court looking at such a fact pattern could reach the same conclusion as was reached in Renkemeyer.
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If you have any questions regarding this Memorandum, please contact Dan Murphy (212-574-1210), Ron Cima (212-574-1471), Jim Cofer (212-574-1688) or Peter Pront (212-574-1221) of our Tax Group.