Are Limited Partners Subject to Self-Employment Tax? Key Exceptions

Whether limited partners are subject to self-employment tax depends on what kind of income they receive and what they actually do in the business. The default rule under Internal Revenue Code section 1402(a)(13) is that a limited partner’s distributive share of partnership profits is excluded from net earnings from self-employment, so it escapes the 15.3 percent Social Security and Medicare levy.¹ But guaranteed payments, active management, professional-service work, and LLC-member status can each pull that income back into the SE tax base.

What the Exclusion Covers

The distributive share is your allocated portion of the partnership’s annual profits or losses. Section 1402(a)(13) treats it as a return on invested capital rather than compensation for labor, which is why it sits outside the Social Security and Medicare system.¹ The legislative history describes the excluded income as “basically of an investment nature”: a person who puts money into a limited partnership and collects returns without working in the business looks more like a stockholder than a sole proprietor.²

General partners get no such break. Their entire distributive share counts as self-employment income, no matter how much hands-on work they do.²³ On a $300,000 distributive share, the SE tax difference between a general partner and a qualifying limited partner can easily exceed $30,000 in a year.

Guaranteed Payments Are Always Taxed

Even a genuine limited partner owes self-employment tax on guaranteed payments received for services. A guaranteed payment is money the partnership pays a partner for work performed, regardless of whether the partnership turned a profit. If a limited partner earns $60,000 for managing the firm’s technology systems, that entire $60,000 is self-employment income subject to the 15.3 percent tax.⁴

A single partner can therefore have two streams of partnership income taxed very differently. The distributive share of profits stays exempt; the guaranteed payments get hit at the full rate. Misclassifying guaranteed payments as part of the distributive share is a flag the IRS knows to look for, and the accuracy-related penalty for a resulting underpayment runs 20 percent of the tax you shorted.⁵

When Active Involvement Blows Up the Exclusion

The exclusion rewards passivity. Start making management decisions, hiring staff, signing contracts, or otherwise running the business, and the IRS can treat you as a general partner for SE tax purposes regardless of what the partnership agreement calls you. The agency looks at what you actually do.

In 1997 the IRS proposed regulations to draw bright lines. Under those proposed rules, a partner would lose limited-partner status for SE tax purposes if any of three conditions applied:

The partner is personally liable for partnership debts by virtue of being a partner.
The partner has authority under state law to bind the partnership to contracts.
The partner participates in the partnership’s business for more than 500 hours during the tax year.

Those regulations were never finalized. Congress blocked the IRS from finalizing them for years, and the agency never acted after the prohibition expired.⁶ The three factors still appear in IRS audit materials as a working framework, but they carry less legal weight than actual regulations would.²

Professional Service Firms Get No Exclusion

The 1997 proposed rules included a blanket override for professional service firms. If substantially all of a partnership’s activities involve services in health, law, engineering, architecture, accounting, actuarial science, or consulting, every partner who provides services in that business is treated as a non-limited partner for SE tax purposes, no matter what the partnership agreement says or how few hours they work.⁶

Courts have agreed. In Renkemeyer, Campbell & Weaver, LLP v. Commissioner, the Tax Court held that partners in a law firm organized as a limited liability partnership could not claim the section 1402(a)(13) exclusion, reasoning that Congress never intended to let people who work in their partnerships as self-employed professionals dodge payroll taxes.² If your firm’s revenue comes primarily from professional services, assume your distributive share is subject to SE tax.

LLC Members and the Circuit Split

The modern LLC didn’t exist when Congress wrote section 1402(a)(13) in 1977. The statute refers to “limited partners,” which had a settled meaning under state limited-partnership law at the time. Whether an LLC member can qualify as a “limited partner” for SE tax purposes has been litigated for decades, and the answer now depends partly on which federal circuit you’re in.

The Tax Court developed a “functional analysis” test in cases including Castigliola v. Commissioner (2017) and Soroban Capital Partners LP v. Commissioner (2023). Under this approach, the court looks at whether the partner actually functions as a passive investor. Participate in the business and you don’t qualify, regardless of your state-law status. The Tax Court read the phrase “limited partner, as such” in the statute as signaling that Congress meant to protect only truly passive investors.

The Fifth Circuit rejected that framework in its 2025 decision in Sirius Solutions, L.L.L.P., holding that “limited partner” simply means a partner with limited liability under state law. If you’re a limited partner under your state’s partnership statute, you qualify for the exclusion, period. The court noted that dictionaries from the 1977 era defined “limited partner” by limited liability rather than passivity, and that the IRS’s functional test creates unworkable uncertainty for taxpayers.

This split creates a real geographic difference. Partners in Texas, Louisiana, and Mississippi have stronger ground to claim the exclusion even when active in the business. Partners elsewhere face the Tax Court’s stricter functional test. Until the Supreme Court or Congress resolves the conflict, the answer to whether your LLC distributions avoid SE tax depends heavily on where litigation would occur. In audits, the IRS still examines the three 1997 factors: personal liability for company debts, authority to bind the entity, and participation hours. Exceeding 500 hours, holding contract-signing authority, or working in a professional service firm all point toward SE tax liability, and the absence of personal liability alone isn’t enough to secure the exclusion.⁶²

Real Estate Rental Income Has Its Own Exclusion

Rental income from real estate is separately excluded from self-employment earnings under section 1402(a)(1), independent of the limited-partner question.¹ A limited partner’s share of rental income from a commercial building or apartment complex is outside SE tax regardless of how the limited-partner analysis comes out. The exception: the rental exclusion doesn’t apply if the rentals are received in the course of a trade or business as a real estate dealer. A developer who buys, subdivides, and sells properties sits in a different position than an investor collecting rent checks.²

What You May Owe Instead: The Net Investment Income Tax

Avoiding SE tax doesn’t mean the income escapes all additional levies. Income that qualifies for the limited-partner exclusion often falls into the 3.8 percent Net Investment Income Tax instead, because income from a passive partnership interest counts as net investment income under section 1411.⁷⁸

The NIIT applies when modified adjusted gross income exceeds $250,000 for married filing jointly or a qualifying surviving spouse, $200,000 for single or head of household, or $125,000 for married filing separately.⁹ A limited partner who earns $90,000 from a passive partnership and has $180,000 in wages ($270,000 total MAGI, filing single) would owe the 3.8 percent tax on $70,000, the amount above the $200,000 threshold. That’s $2,660, well under the roughly $13,770 in SE tax the same income would have generated, but not zero. Income that is subject to SE tax is generally excluded from the NIIT, so the same dollar doesn’t get hit twice.⁸ The thresholds are set by statute and aren’t indexed for inflation.

How to Read Your K-1

The partnership reports each partner’s self-employment earnings on Schedule K-1 (Form 1065). The key number is Box 14, Code A: net earnings or loss from self-employment.¹⁰ General partners carry that figure to Schedule SE. Limited partners who receive only a distributive share and no guaranteed payments should see a zero or blank in Box 14, Code A. If a number shows up there and you believe you qualify for the exclusion, raise it with the partnership’s tax preparer before filing.

Limited-partner status for SE tax purposes turns less on your partnership agreement and more on what you actually do in the business, the field the partnership operates in, and, increasingly, which federal court would hear your case if the IRS disagrees with your position.

1
Office of the Law Revision Counsel. 26 USC 1402 – Definitions
2
Internal Revenue Service. Self-Employment Tax and Partners
3
Internal Revenue Service. Self-Employment Tax (Social Security and Medicare Taxes)
4
Internal Revenue Service. Entities
5
Office of the Law Revision Counsel. 26 USC 6662 – Imposition of Accuracy-Related Penalty on Underpayments
6
Internal Revenue Service. Definition of Limited Partner for Self-Employment Tax Purposes
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Office of the Law Revision Counsel. 26 USC 1411 – Imposition of Tax
8
Internal Revenue Service. Questions and Answers on the Net Investment Income Tax
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Internal Revenue Service. Topic No. 559, Net Investment Income Tax
10
Internal Revenue Service. Partners Instructions for Schedule K-1 (Form 1065)