We have heard rumblings that the IRS is actively auditing a number of investment professionals who have taken the position that they are not subject to self-employment tax on their share of net income from their limited partnership interests in management entities.

Individuals generally are subject to self-employment tax on "net earnings from self-employment" derived from conducting a trade or business directly or indirectly through a partnership.  However, under Section 1402(a)(13), a limited partner's distributive share of income from a limited partnership generally is not subject to self-employment tax. 

Accordingly, to minimize their self-employment taxes, individual investment professionals often organize a limited partnership (Manager LP) to manage, and receive management fees from, funds and managed accounts.  The investment professionals hold limited partnership interests in Manager LP, and also organize (and collectively own) membership interests in an limited liability company (GP LLC), which holds the general partnership interest in Manager LP and typically is entitled to only 1% of Manager LP's net income.  The investment professionals take the position that they are subject to self-employment tax only on their share of income from GP LLC (i.e., 1% of Manager LP's net income), but not on the remaining 99% of Manager LP's net income, which they receive as limited partners.

In 2011, the Tax Court held in Renkenmeyer v. Commissioner that law firm partners who actively participated in a limited liability partnership were not "limited partners" within the meaning of Section 1402(a)(13).  Investment professionals have sought to distinguish their facts from those in Renkenmeyer by noting that (1) they are partners in a limited partnership that has a general partner (whereas a limited liability partnership, such as the one in Renkenmeyer, does not have a general partner), and (2) the general partner actively participates in the partnership.

An early draft of the Tax Cuts and Jobs Act proposed to repeal the "limited partner" exception from self-employment tax under Section 1402(a)(13) of the tax code.  The final version of the Tax Cuts and Jobs Act did not in fact repeal the exception. 

Nevertheless, in March 2018, the IRS Large Business and International division announced its intent to focus on individuals who "have inappropriately claimed to qualify as 'limited partners' not subject to [self-employment] tax."

Consistent with this announcement, we recently have heard informal reports that the IRS is scrutinizing the self-employment tax positions of a large number of individual investment professionals, including professionals who hold limited partnership interests (and not limited liability partnership interests, like the law firm partners in Renkenmeyer).