Taxpayers have long attempted to limit the application of the Self-Employment Contributions Act (SECA ) taxes to income that is akin to employment income and not investment, or passive income, by relying on Code §1402(a)(13).[1] That section provides that the SECA base excludes the distributive share of income or loss of a limited partner other than guaranteed payments to that partner for services actually rendered to or on behalf of the partnership.

In 2022 followed by June 2023, Tax Court cases were docketed that evidence the Internal Revenue Service’s (IRS) position that the bifurcation of a persons’ interest in an investment partnership into two tranches — one that produces compensation income and the other that produces a distributive share that is not compensation, is not feasible.[2]

In both cases the partnership had gone to some pains to compensate partners at what they apparently believed were fair market values for the work they performed on behalf of the partnership and those amounts were subjected to SECA. The IRS’ argument is that not only is the guaranteed payment subject to SECA, but the distributive share of net profit is also subject to SECA. Reading the taxpayers petitions, the IRS’ argument is based on the position that the individuals are not “limited partners” as that term is used in Section 1402(a)(13).

That argument was met with success in a number of cases in which the entity taxed as a partnership was not a state limited partnership in form. For...

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