On September 5, the IRS released a Chief Counsel Advice (“CCA”) concluding that the limited partner exception to self-employment taxes is not available to members of an LLC that received fees for managing investment funds. Based on that conclusion, all profits of the management company allocated to the members are subject to the 3.8% Medicare portion of the self-employment tax.
As background, limited partners are generally not subject to self-employment taxes on their shares of a partnership’s income, other than guaranteed payments (e.g., salaries). In the CCA, the IRS concluded that earnings that are the direct result of services rendered, rather than a return on capital investment, do not qualify for the limited partner exception. The CCA relied heavily on Remkemeyer, 136 TC 137 (2011). Other pertinent decisions include the 2012 decisions in Howell and Riether.
The Fund management company in the CCA is a limited liability company classified as a partnership for tax purposes. Although the CCA does not address management companies structured as limited partnerships, its analysis suggests it would also deny the limited partner exception to investment professionals who are limited partners in a limited partnership.
Nevertheless, structuring a Fund management company as a limited partnership rather than an LLC puts investment professionals in a stronger position to claim the limited partner exception. Also, investment professionals seeking to limit self-employment taxes could structure their management companies as S corporations. In that case, potential IRS challenges would probably be limited to whether salaries to shareholders/managers are unreasonably low so that dividends should be recharacterized as compensation subject to FICA taxes.
CCAs merely provide advice to IRS field agents and may not be cited as precedent and do not constitute definitive authority, but this CCA is a warning of likely IRS challenges to the use of the limited partner exception by investment professionals.
At Robinson Bradshaw, Herman Spence handles the tax aspects of mergers, acquisitions, financings, and other corporate and real estate transactions, and he has extensive experience representing solar energy investment funds.