Karen C. Burke (University of Florida Levin College of Law) has posted The Original Meaning of “Limited Partner”, 104 Tax Magazine (forthcoming 2026), on SSRN. Here is the abstract:
The First, Second, and Fifth Circuits may soon be required to determine the meaning of “limited partner” for purposes of Code Sec. 1402(a)(13). Enacted in 1977, Code Sec. 1402(a)(13) exempts from self-employment tax the distributive share of a limited partner acting “as such.” The underlying issue is whether the term “limited partner,” not defined in the statute, should be interpreted as meaning a partner who is functionally equivalent to a passive investor, thus requiring an analysis of the nature and scope of the partner’s role in the partnership’s business. By contrast, a state-law characterization approach would classify limited partners based solely on whether they have limited liability under state law, regardless of how actively they participate in the partnership’s business. During the nearly half century since enactment of Code Sec. 1402(a)(13), the evolution of state statutes and the rise of new organizational forms have eroded the historical meaning of limited partner.
Investment partnerships employ tiers of related entities to minimize employment taxes by blurring the capacity in which active limited partners render investment services for which they receive investment management fees. The general partner (GP) or fund manager is organized as a limited liability company (LLC) taxed as a partnership and the lower-tier management company is typically a state-law limited partnership whose individual limited partners (LPs) also own interests (directly or indirectly) in the GP or fund manager. Exploiting liberal state-law provisions, active limited partners work fulltime in the limited partnership’s business; they claim to be acting merely as employees or agents of the general partner, rather than managing the partnership’s business in their capacity as limited partners. Active limited partners are careful to avoid any actions that would potentially jeopardize their claim to limited liability under state law.
Part II of this article considers the origins of Code Sec. 1402(a)(13), which was originally intended to prevent limited partners from obtaining Social Security benefits for investment-type income earned through a partnership. Part III explores the central problem in 1977 of “hybrid” partners, i.e., active limited partners who overstepped the murky “control” line and risked losing limited liability under state law. Part IV examines three alternative approaches to determining the 1977 meaning of limited partner—state law characterization, limited liability, and activity versus control—while Part V discusses the emergence of state-law safe harbors that allowed limited partners to participate more actively. Part VI suggests that the limited-partner exception is anachronistic and now serves only to facilitate an egregious employment-tax loophole.
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