An Agency Under Siege
The mission statement of the IRS reminds taxpayers that it is their responsibility to understand and meet their tax obligations, while it is the role of the IRS to “enforce the [tax] law with integrity and fairness to all” to ensure that those obligations are satisfied.
The IRA
In 2023, following the $80 billion of funding authorized for the agency by the Inflation Reduction Act (the “IRA”),[i] the IRS announced it was going to increase its enforcement efforts with regard to wealthy and high-earning taxpayers, and the complex partnerships they employ,[ii] to ensure these taxpayers were held accountable for the full amount of taxes they owed.
Progress on Enforcement
A few months later, in early 2024, the IRS announced progress in the expansion of its enforcement activities related to the above-referenced taxpayers, thanks to the resources provided by the IRA.[iii]
SECA
Of interest to today’s post, the IRS indicated that, as part of its enhanced focus on the tax issues arising from the use of partnerships, the agency would be increasing its enforcement efforts to ensure that SECA taxes[iv] were being properly reported and paid by wealthy individual partners who provide services to their partnerships but claim to be exempt from SECA tax based upon their status as “limited partners” in state law limited partnerships.
The IRS highlighted one success in particular – the U.S. Tax Court’s opinion last November in Soroban Capital Partners LP v. Comm’r,[v] in which the Court agreed with the IRS that the limited partner exception to SECA tax did not apply to a partner who was “limited” in name only.[vi]
According to the IRS, partners who actively participate in a state law limited partnership must report their share of partnership profit as net earnings from self-employment (“NESE”) subject to the tax.[vii]
More on this shortly.
The Brakes Are Applied
Of course, in January of this year, the new Administration ordered a hiring freeze for the IRS.[viii] Then, in early April, the Treasury Department announced that it expected to cut up to half of the IRS’s enforcement personnel.[ix]
Last Friday, the Administration proposed a reduction of about $2.5 billion to the IRS’s annual budget – which is in addition to the reduced funding provided under the IRA, which has been clawed back to under $38 billion – for the 2026 fiscal year,[x] as compared to last year’s annual funding.[xi]
Return on Investment?
Last week, the IRS issued its annual Data Book[xii] detailing the agency’s activities during fiscal year 2024.[xiii]
For the first time, the revenue collected by the agency exceeded $5 trillion dollars, which accounted for about 96% of all government funding. In FY 2024, the IRS closed 505,514 tax return audits, resulting in $29 billion in recommended additional tax.[xiv] The agency also collected almost $77.6 billion[xv] of federal taxes that were reported or assessed but not paid.[xvi]
Tax Gap
What does this mean for the so-called “tax gap”? It’s too early to tell. The most recent tax year for which the IRS has estimated the tax gap is 2022.[xvii] The agency found that the amount of “true” tax liability that was not paid voluntarily and timely for that year was about $696 billion, which the IRS broke down as follows:
- Individual income tax – $514 billion
- Employment tax (including SECA) – $127 billion
- Corporate tax – $50 billion
- Estate tax – $5 billion
More SECA Cases
Meanwhile, the IRS’s pre-2025 efforts, following shortly after the Tax Court’s initial, 2023 decision in Soroban, have resulted in the filing of petitions by several other partnerships that are challenging the IRS’s “functional analysis” approach to characterize their limited partners’ distributive shares of partnership income as NESE.[xviii] More on this shortly.
Soroban Capital Partners – Part II
After the Tax Court’s approval, in Soroban I, of the functional analysis applied by the IRS to the roles of Soroban’s partners to determine whether they were bona fide limited partners, the parties filed a joint motion, in August 2024, to submit the case to the Court for decision without a trial.[xix]
Last week, the Tax Court issued its opinion. Before delving into the Court’s reasoning, a review of the applicable provisions of the Code may be helpful.[xx]
The Code
In addition to the income tax, the Code imposes annual taxes of 12.4% and 2.9% on an individual taxpayer’s self-employment income for the taxable year.[xxi]
An individual taxpayer’s “self-employment income” means the net earnings from self-employment derived by the individual during any taxable year.[xxii]
The individual taxpayer’s “net earnings from self-employment” (“NESE”) includes the gross income derived by the individual from any trade or business carried on by such individual, less the allowable deductions which are attributable to such trade or business.
NESE also include the taxpayer’s distributive share (whether or not distributed) of income or loss[xxiii] from any trade or business carried on by a partnership of which the taxpayer is a member.[xxiv]
Notwithstanding the foregoing, the Code excludes certain items of income from NESE. For example, rentals from real estate are excluded unless such rentals are received in the course of a trade or business as a real estate dealer; so are dividends on any share of stock, and interest on any bond, note, or other evidence of indebtedness, unless such dividends and interest are received in the course of a trade or business as a dealer in stocks or securities; likewise, gain or loss from the sale or exchange of a capital asset is excluded, as is gain from the sale or exchange of property which is not included in inventory or held primarily for sale to customers in the ordinary course.[xxv] In other words, investment income is excluded from NESE.
Amounts received by a partner on account of their retirement are excluded provided certain conditions are satisfied, including the requirement that the partner rendered no services with respect to any trade or business carried on by the partnership during the taxable year in which such amounts were received.[xxvi] Again, a distinction is made between the passive receipt of payments and the receipt of consideration for services rendered.
Most relevant for this post, a taxpayer’s NESE excludes “the distributive share of any item of income or loss of a limited partner, as such,”[xxvii] other than guaranteed payments[xxviii] to that partner “for services actually rendered to or on behalf of the partnership to the extent that those payments are established to be in the nature of remuneration for those services”[xxix] (the “Exclusion”). As indicated earlier, a distribution in respect of an investment made as a limited partner is treated differently than a payment of consideration for services.
Legislative History[xxx]
The Exclusion was added to the Code in 1977.[xxxi] The summary of the legislation prepared by the Senate Finance Committee explained that:
“In recent years, a growing number of businesses have offered limited partnerships as a means of acquiring social security coverage solely through the income on investments in such partnerships. The bill excludes from social security coverage the distributive share of income or loss which a limited partner receives from a trade or business.”[xxxii]
According to a report prepared by the House Ways and Means Committee, “[t]he income from a partnership which is received by a limited partner who performs no service for the partnership will be excluded from social security coverage.”[xxxiii]
A related report prepared by the Social Security Administration stated that the addition of the Exclusion to the Code was intended “to exclude from coverage the distributive share of income or loss of a partnership received by a limited partner who does not perform any services for the partnership.” The report then summarized the new provision as follows:
“Effective for taxable years beginning, after December 31, 1977, the distributive share of income or loss from the trade or business of a partnership received by a limited partner who performs no service for the partnership are excluded from social security coverage. Under the old law, a partner’s share of partnership income was includable in his net earnings from self-employment irrespective of the nature of his membership in the partnership.”
The subcommittee on Social Security of the House Ways and Means Committee summarized the provision as follows:
“[It] excludes for social security coverage purposes the distributive share of income or loss from the trade or business of a partnership received by a limited partner who performs no service for the partnership.
“The exclusion from coverage does not extend to guaranteed payments such as salary and professional fees, received for services actually performed by the limited partner for the partnership, or distributive shares received as a general partner.”[xxxiv]
Finally, another report issued by the Subcommittee on Social Security of the House Ways and Means Committee explained that “the bill would exclude from coverage as self-employment income certain limited partnership income which is more in the nature of investment income than compensation for actual services performed.” The former is excluded from NESE, the latter is not.
Now let’s turn to the facts of the case and the Court’s application of the foregoing principles.
Soroban – Part II
Soroban Capital Partners LP (“Soroban”) was a Delaware limited partnership with its principal place of business in New York City. For the years in issue, Soroban had four partners: one general partner (“GP”)[xxxv] and three limited partners (the “Principals”).
GP was a Delaware LLC and was classified as a partnership for federal income tax purposes. It had three members – the Principals.[xxxvi]
Thus, Soroban’s three limited partners were also the members of GP;[xxxvii] considering the Principals’ direct and indirect interests, they owned 100% of Soroban.
Soroban’s Income
During the years in issue, Soroban earned its income from the fees it charged its clients in exchange for providing management services with respect to various investment funds.[xxxviii]
Soroban’s limited partners – the Principals – played an essential role in generating this income. Soroban acknowledged that the limited partners’ unique skills and experience were indispensable to its business. The limited partners exercised managerial control over Soroban and worked full time with Soroban. They contributed little to no capital relative to their shares of income.
Tax Treatment
When calculating its partners’ NESE for the years in issue, Soroban included only the guaranteed payments[xxxix] it had made to its limited partners (the Principals) – an aggregate amount of approximately $1.25 million in each of the two years.[xl] According to Soroban, these payments represented the “net incentive and management fees earned from” the funds by Soroban.
Soroban otherwise excluded from its calculations of NESE the limited partners’ shares of partnership income – an aggregate amount of approximately $77.66 million and $63.87 million for those years.[xli]
Soroban reported the income allocated to GP – i.e., $785,335 and $645,965 (1% of Soroban’s profits) – as self-employment earnings.
The ownership interests that GP reported for its three members (the Principals) were approximately the same as their limited partner interests in Soroban.
GP reported as NESE to its three members (the Principals) GP’s entire share from Soroban – a total of $785,335 in one year, and $645,965 in the other.
The funds accounted for their payments to Soroban – representing Soroban’s income from the fees it charged its clients – as expenses paid or incurred in exchange for management services.
Management Activities
The management agreements between Soroban and the funds provided: “As consideration for the services rendered pursuant to this Agreement, [Soroban] shall be entitled to receive the Management Fees described in the Offering Memoranda.”
Soroban advertised these arrangements to its potential clients. Soroban solicited potential investors with descriptions of the features of the funds in private placement memoranda that described the fees paid by the investors to Soroban as “Management Fees.”
The Principals managed both the investments and the operations of Soroban and the funds it managed. They were responsible for portfolio management, research, and risk management. They managed trade orders. They served on all of the committees that oversaw the operations of Soroban.
Although certain daily business operations were handled by certain key employees other than the Principals, the Principals nonetheless exercised control over Soroban’s daily business operations, including hiring and firing.
Soroban’s limited partnership agreement provided that only GP, as the general partner of Soroban, would be able to bind or manage Soroban. In turn, the general partners of GP were the three Principals.
All three Principals treated Soroban as their full-time jobs, as required under the partnership agreement. They worked between 2,300 and 2,500 hours per year during the years in issue – they devoted their full attention to the business.
The Principals’ “Contributions”
Only one of the Principals contributed assets to Soroban[xlii] of which approximately 29% were used for organizational and startup expenses; the remainder was used for operating expenses. These cash contributions were the only capital contributions Soroban received from the Principals from its formation through the years in issue.[xliii]
Apart from this cash, the Principals contributed their know-how, investment track records, and relationships with potential investors to the success of Soroban. Although not explicitly stated by the Court, the only way to convey these intangibles was by rendering services to the partnership – they were of no significance in the absence of the Principals to whom they “belonged.”
Indeed, Soroban advertised the unique skills and talents of the Principals to potential investors. The advertising materials enticed investors with access to the Principals’ unique talents. Soroban explained that it would invest in areas in which the Principals had experience.
Soroban’s advertisements explained that the Principals’ participation in Soroban was critical to the Fund’s success and cautioned that “[t]he success of the Fund will depend, in large part, upon the skill and expertise of the management of Soroban. In the event of the death, disability, or departure of any Principals,” the advertisement materials stated, the business and the performance of the funds may be adversely affected. If all three Principals were unavailable, the funds would liquidate – in other words, but for the three Principals, Soroban would not exist.
In the private placement memorandum that Soroban provided prospective investors, Soroban acknowledged that one of the Principals, in particular, was essential to the operation of the business. If for any reason this Principal permanently ceased to be responsible for overseeing the investment of the assets of the funds, the investors had the option to withdraw all or a portion of their investment with the funds.
Tax Court
The IRS timely issued FPAAs to GP for the years in question, in which the agency alleged the Principals were not limited partners for the purpose of the Exclusion and, consequently, proposed recharacterizing as NESE the ordinary income allocated to the Principals ostensibly as Soroban’s limited partners.
Acting on behalf of Soroban, GP petitioned the Tax Court to reject the proposed adjustments. GP also filed a motion for summary judgment, asking the Court to find that the Code,[xliv] on its face, excludes limited partners’ distributive shares of income from NESE and, thus, self-employment tax (SECA) applied only to the Principals’ guaranteed payments. For this purpose, GP argued that characterization of the Principals as limited partners for state law purposes was controlling. Period.
The IRS filed a cross-motion for partial summary judgment, arguing that the Code requires a functional inquiry into the roles of the partners to determine whether they are bona fide limited partners.
The Court granted the IRS’s motion and denied GP’s, holding that the Code requires a functional inquiry into the roles and responsibilities of the partners.
The parties’ submissions focused on the meaning of the term “net earnings from self-employment” and on the exclusion therefrom for “the distributive share of any item of income or loss of a limited partner, as such, other than guaranteed payments.”
Court’s Functional Analysis
The Court explained that it had to determine whether Soroban’s partners – i.e., the Principals – qualified as limited partners for purposes of the Exclusion.[xlv]
According to the Court’s earlier holding, in Soroban I, this required a functional analysis into the roles and responsibilities of these partners.[xlvi]
A functional analysis, the Court stated, is designed to be an inquiry into whether the Principals “were ‘generally akin’ to passive investors.” Under this test, to exclude a partner’s distributive share of partnership income from NESE, “the surrounding circumstances of the partner’s economic relationship with the partnership must sufficiently indicate that it is generally one of passive investment.”
After pointing out that GP had the burden of establishing that the Principals’ distributive shares represented income of an investment nature, the Court analyzed the Principals’ roles and responsibilities in Soroban and GP, and in the two partnerships’ business activities.
Specifically, the Court reviewed the sources of Soroban’s income for the years in issue, the Principals’ roles in generating that income, and the relationship between the Principals’ distributive shares of Soroban’s profits and the capital contributions they made to the partnership.[xlvii]
According to the Court, Soroban generated income from fees it charged its clients for managing investments. The Principals’ time, skills, and judgment were essential to these services. The funds were managed by the Principals: they were responsible for managing risk, managing trade offers, overseeing and participating in the investment process. This work contributed to the generation of Soroban’s income, which was substantial across the years in issue.
The Principals participated in the management of Soroban. All three Principals served on the firm’s brokerage, trade allocation, management, and valuation committees. They made decisions related to hiring, firing, promoting, and evaluating employees. When not acting by committee, the Principals exercised authority delegated to them by GP to negotiate and execute any agreement or document to conduct Soroban’s business.
In response to GP’s argument that this work was not done by the Principals alone, and that it would be inappropriate to attribute the generation of Soroban’s income solely to the Principals, the Court observed that, although Soroban employed people other than the Principals to assist with the operations of the business, the Principals maintained control over such operations and exercised authority over the core functions of the business.
The Principals, the Court continued, devoted significant time to the business. In materials prepared for the investors, Soroban represented that “100% of [the Principals’] time [was] devoted to the management and investment activities of [Soroban] and the funds it manages.” The Principals devoted their full-time efforts to actively pursuing the business of Soroban.[xlviii]
The expertise of the Principals was a selling point for potential investors. In presentations for investors, Soroban advertised the unique skill and experience of the Principals, which was so crucial that, if no Principal were available to manage the funds, the funds would liquidate.
Next, the Court considered the Principals’ insignificant capital contributions which, according to the Court, demonstrated that their distributive shares of income were not returns on investment. The Court explained that when the size of a partner’s investment is relatively small in comparison to the fees the partnership charges for services it provides, the small investment is not sufficient to classify the partner’s distributive share as a return on investment.
Two of the Principals did not contribute capital to Soroban, so their distributive share of partnership profits, the Court stated, was not a return on an investment of capital.
Although the third Principal contributed $4 million in capital, his contributions were disproportionate to the $80 million distributed to him over the two years in issue, during which Soroban generated roughly $247 million of income. The Court asserted that the disproportionate income generated did not indicate a return on an investment of capital.
Economic Reality vs. Labels
The foregoing aside, the Court stressed that the test of whether a partner functions as a limited partner for federal tax purposes is not dictated by any set number of factors. Rather, it is a facts and circumstances test that examines all relevant facts and circumstances.[xlix] The “labels” placed on a partner for state law purposes, the Court stated, were the least relevant factors to consider because they may be inconsistent with the economic reality of a partner’s relationship with the entity. For example, a partner labeled a limited partner who works for the partnership’s business full time, whose work is essential to generating the business’s income, who is held out to the public as essential to the business, and who contributes little or no capital, is not functioning as a limited partner, the Court stated, regardless of the label placed on that partner.
According to the Court, GP relied on the “fiction” that the Principals did not serve Soroban in their individual capacities as limited partners and acted with authority delegated to them by GP, which they in turn had the authority to manage. This type of legal fiction, the Court explained, was why application of federal tax law to the economic arrangement of the parties controlled, and not mere state law classifications. Soroban relied on the Principals to function. Their unique skills and expertise helped the business to manage large investment funds, which, in turn, generated income for the business. If the Principals were unable to participate in the business, clients would have had a right to a return of their investments and the funds would have liquidated. Thus, the Principals’ roles in the business were not those of passive investors.
The Principals’ shares of ordinary income bore no relationship to their capital contributed or their capital accounts. “Thus it is clear that the partners’ distributive shares of the . . . firm’s income did not arise as a return on the partners’ investment and were not ‘earnings which are basically of an investment nature.’”[l]
Holding
Based on the foregoing, the Court concluded that Soroban’s limited partners were limited partners in name only.
The Principals were essential to generating the business’s income, they oversaw day-to-day management, they worked for the business full time, and they were held out to the public as essential to the business. Their capital accounts made clear that their earnings were not of an investment nature.
They were not limited partners within the meaning of the Exclusion, and their earnings constituted NESE for the years in issue.
What’s Next?
It is likely the decision in Soroban will be appealed to the Second Circuit. Meanwhile, other taxpayers have already appealed the same issue to the First and Fifth Circuits, respectively; in fact, the Fifth Circuit heard oral arguments in February.[li] Of course, a decision by any of these Circuits would bind the Tax Court only within that Circuit.[lii]
How’d We Get Here?
Prior to the enactment of the Exclusion, the Code provided that a partner’s share of partnership income was includable in their net earnings from self-employment for tax purposes, regardless of the nature of the partner’s membership in the partnership.
In creating the Exclusion for limited partners, Congress recognized that certain earnings were basically in the nature of a return on investment, which should not be taxed under SECA. Thus, the Exclusion was not extended to guaranteed payments received for services rendered by the limited partner to the partnership.
In 1997, in response to the proliferation of LLCs, the IRS issued proposed regulations defining “limited partner” for self-employment tax purposes. These generally provided that an individual member of an LLC would be treated as a limited partner who is not subject to SECA tax, unless the individual: (1) had personal liability for the debts of or claims against the partnership by reason of being a partner; (2) had authority to contract on behalf of the partnership; or (3) participated in the partnership’s trade or business for more than 500 hours.[liii]
In response to criticism from the business community, Congress imposed a temporary moratorium on finalizing the proposed regulations, which has long since expired, yet the proposed regulations have neither been finalized nor withdrawn,[liv] thereby leaving to the Courts the responsibility for interpreting the Exclusion.
Which is exactly what the Tax Court did in Soroban. I think the Court (and the IRS) got it right. Let’s walk through the reasoning.
Hear Me Out
The wages paid to non-owner-employees of a business in exchange for their services are subject to employment taxes, regardless of how the business is organized.
Self-employed individuals are generally subject to employment taxes on their net earnings.
The shareholders of a corporation are not subject to employment taxes in respect of any return on their investment in the corporation, though they are subject to employment taxes as to any wages paid to them by the corporation.
In the case of S corporations, the IRS has sought, over the years, to compel them to pay their shareholder-employees a reasonable wage for services rendered to their corporations and thus prevent them from “converting” taxable compensation for services into a distribution of investment income that is not subject to employment taxes. Of course, this begs the question: what is reasonable compensation? Among the factors to be considered in making this determination is the unique skillset of the employee and how crucial it is to the success of the business.[lv]
Generally, partners receive partnership interests in exchange for contributions of cash and/or other property, while certain partners receive such interests in exchange for some combination of cash and/or other property plus services, while others receive interests solely in exchange for their services to the partnership. This last category of partnership interests are typically interests in future partnership profits and appreciation[lvi] – basically, “profits interests.”
Historically, the IRS has stated that bona fide members of a partnership are not employees of the partnership for employment tax purposes. According to the IRS, a partner who devotes their time and energy in the conduct of the trade or business of the partnership, or in providing services to the partnership as an independent contractor, is treated as a self-employed individual.[lvii]
Thus, although profits interests are structured as partnership interests, the income allocable to such interests is received in connection with the performance of services and, as such, should be subject to self-employment tax.[lviii]
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The opinions expressed herein are solely those of the author(s) and do not necessarily represent the views of the Firm.
[i] The Inflation Reduction Act of 2022, P.L. 117-169, provided almost $80 billion in funding to improve IRS enforcement, as well as other functions. However, Congress has steadily reduced this amount to $37.6 billion. https://www.tigta.gov/inflation-reduction-act-oversight#:~:text=The%20Inflation%20Reduction%20Act%20(IRA,increase%20compliance%20and%20enforcement%20actions.
[ii] https://www.irs.gov/newsroom/irs-announces-sweeping-effort-to-restore-fairness-to-tax-system-with-inflation-reduction-act-funding-new-compliance-efforts.
[iii] https://www.irs.gov/newsroom/irs-ramps-up-new-initiatives-using-inflation-reduction-act-funding-to-ensure-complex-partnerships-large-corporations-pay-taxes-owed-continues-to-close-millionaire-tax-debt-cases#:~:text=Partnership%20Self%2DEmployment%20Tax%20Initiative,by%20wealthy%20individual%20partners%20who.
Specifically, the IRS stated that, as a result of its increased scrutiny of high-income taxpayers, it had already collected over $480 million of tax owed by 1,600 millionaires and promised to continue its efforts to reverse what it described as “the historic low audit rates” of such individuals.
[iv] The Self-Employment Contributions Act. The SECA tax requires self-employed individuals to pay Social Security and Medicare taxes in respect of their net earnings from self-employment. The tax rate is 15.3%, which consists of two parts: 12.4% for social security and 2.9% for Medicare.
[v] 161 T.C. 310 (2023) (Soroban I).
[vi] In April 2022, the IRS had timely issued two Notices of Final Partnership Administrative Adjustments (“FPAAs” – the equivalent of a notice of deficiency) to the limited partnership (“LP”) for the two taxable years in issue. The IRS proposed recharacterizing the ordinary income allocated to Soroban’s limited partners as net earnings from self-employment, thereby increasing such earnings by approximately $78 million in one year and $64 million in the other.
[vii] The Court concluded that a functional inquiry into the roles and responsibilities of the partners was necessary to determine whether they were bona fide limited partners for purposes of the SECA tax.
[viii] https://www.whitehouse.gov/presidential-actions/2025/01/hiring-freeze/.
[ix] https://federalnewsnetwork.com/reorganization/2025/04/treasury-plans-to-cut-up-to-50-of-irs-enforcement-staff-20-of-other-components/#:~:text=The%20Treasury%20Department%20expects%20to,of%20a%20major%20agency%20reorganization.
[x] Ending September 30, 2026.
[xi] The prior administration proposed $12.3 billion last year.
[xii] The Data Book provides a fiscal year statistical overview of the agency’s operations including returns received, revenue collected, taxpayer services provided, tax returns examined (audits), efforts to collect unpaid taxes and other details about the work of the IRS. https://www.irs.gov/pub/irs-pdf/p55b.pdf.
[xiii] Oct. 1, 2023 – Sept. 30, 2024.
[xiv] Approximately 0.58% of total tax collections. (That’s 0.0058.)
[xv] Approximately 1.55% of total tax collections.
[xvi] In FYE Sept. 30, 2023, the IRS collected approximately $4.7 trillion, processed more than 271.4 million tax returns, and closed 582,944 tax return audits, resulting in $31.9 billion in recommended additional tax.
Early last year, the Congressional Budget Office estimated that a $1 increase in spending on the IRS’s enforcement activities results in approximately $6.40 of increased revenues. https://www.cbo.gov/publication/60037.
Other sources disagree with the CBO’s data and the conclusions drawn therefrom. For example, in late 2024, the Economic Policy Innovation Center asserted that every $1 of new revenue from the enforcement efforts has cost taxpayers $1.04. https://epicforamerica.org/federal-budget/irs-enforcement-spending-has-not-reduced-the-deficit/#_ftnref2.
[xvii] https://www.irs.gov/statistics/irs-the-tax-gap#:~:text=The%20gross%20tax%20gap%20is%20the%20amount%20of%20true%20tax,Estate%20tax%20$5%20billion.
[xviii] For example: Point72 Asset Management filed its petition with the Tax Court in August 2023 (Docket No. 12752-23); Denham Capital Management filed its petition in June 2023 (Docket No. 9973-23), the Court held for the IRS in T.C. Memo 2024-114 (Dec. 2024), the taxpayer appealed to the 1st Circuit in April 2025 (No. 25-01349); Sirius filed two petitions, in 2020 and 2021 (for 2014 and 2016)(Docket Nos 11587-20 and 30118-21), the taxpayer requested entry of decision based on the precedential status of Soroban (in Feb. 2024) to allow it to appeal to the 5th Circuit (May 2024)(No. 24-60240), which heard oral argument in Feb. 2025. There are others for which petitions were filed fairly recently (in November 2024, Jan. 2025, March 2025, and April 2025).
[xix] Tax Court Rule 122. Any case not requiring a trial for the submission of evidence (as, for example, where sufficient facts have been admitted, stipulated, established by deposition, or included in the record in some other way) may be submitted by motion of the parties to the Court.
[xx] T.C. Memo. 2025-52 Soroban Capital Partners v. Commissioner, Docket Nos. 16217-22, 16218-22. Filed May 28, 2025.
[xxi] IRC Sec. 1401(a) and IRC Sec. 1401(b); the Social Security and Medicare taxes, respectively. The first tax is not applied to that part of the individual’s net earnings from Self-employment which is in excess of the contribution base determined under the Social Security Tax. IRC Sec. 1402(b).
[xxii] IRC Sec. 1402(b).
[xxiii] Described in IRC Sec. 702(a)(8).
[xxiv] IRC Sec. 1402(a).
[xxv] IRC Sec. 1402(b).
[xxvi] IRC Sec. 1402(b)(10).
[xxvii] Meaning, in their capacity as a limited partner.
[xxviii] Described in section 707(c).
[xxix] IRC Sec. 1402(b)(13).
[xxx] All of the following materials may be found at: https://www.ssa.gov/history/pdf/Downey%20PDFs/Social%20Security%20Amendments%20of%201977%20Vol%203.pdf.
[xxxi] P.L. 95-216. “Social Security Amendments of 1977.”
[xxxii] Does this mean the limited partner is “merely” an investor?
[xxxiii] In other words, as an investor, the limited partner does not perform any services for or on behalf of the partnership?
[xxxiv] Meaning, these services are not provided by the limited partner in their capacity as such?
[xxxv] As the only general partner of Soroban, GP is also the tax matters partner.
[xxxvi] The Principals’ relative interests in GP were approximately the same as their interests in Soroban.
[xxxvii] Two of the Principals were single-member limited liability companies that were disregarded for federal income tax purposes. Thus, the limited partner and LLC membership interests held by the LLCs were treated as being held directly by each LLCs’ respective member. See Treas. Reg. Sec. 301.7701-1(a)(4) and Sec. 301.7701-3(b)(1)(ii).
[xxxviii] The funds compensated Soroban according to the value of the fund assets as well as their performance.
[xxxix] Relatively insignificant compared to the income allocated to the limited partners.
[xl] A total of $2.5 million for the two years.
[xli] On its federal partnership tax returns (Form 1065, U.S. Return of Partnership Income) for the years in issue, Soroban reported GP as having a small interest in the profits and capital of the partnership, while the three limited partners, in the aggregate, held 99% of profits and between 97% and over 99% of capital.
[xlii] He contributed $3,539,117 to Soroban in 2010, $800,000 in 2011, and $15,000 in 2013, bringing his total contributions to $4,354,117. Soroban adjusted its balance sheet to reflect this amount in 2013.
[xliii] Nowhere in the opinion does the Court indicate whether the contributor-Principal received equity in Soroban in exchange for this contribution; presumably, he did.
[xliv] IRC Sec. 1402(a)(13).
[xlv] As stated earlier, the Court had previously found it has jurisdiction to determine whether a state law limited partner should be characterized as a limited partner for federal SECA tax purposes.
[xlvi] The Court added that it remained mindful that “federal tax law, and only federal tax law, controls the classification of ‘partners’ and ‘partnerships’ for federal tax purposes.”
[xlvii] The Court looked at the extent to which the Principals’ time, skills, and judgment were essential to the partnership’s income. It evaluated what roles the Principals played in the business – i.e., whether they served as employees, sat on committees, possessed the authority to bind the partnership, or took part in personnel decisions. The Court considered the time the Principals devoted to the business. It looked to how the partnership advertised itself to the public, and whether it advertised any specific skills or expertise of the partners. And it examined the capital contributed by the partners.
[xlviii] Soroban estimated that the Principals worked between 2,300 and 2,500 hours annually during the years in issue.
[xlix] GP proposed its own list of factors for a functional analysis test. The proposed test has nine factors: (1) whether the limited partner was treated as a limited partner under applicable state law; (2) whether the limited partner engaged in any conduct that would result in the limited partner’s losing his status as a limited partner under state law; (3) whether the limited partner also held an interest in the partnership as a general partner; (4) whether the limited partner had a capital investment in the partnership; (5) whether the limited partner received separate compensation for any services provided to the partnership; (6) whether the earnings of the partnership were solely attributable to services provided by the limited partners; (7) whether the amount of earnings allocated to each limited partner was determined by reference to the services provided by that limited partner to the partnership; (8) whether the terms of the limited partnership agreement authorized the limited partners, in their capacity as limited partners, to exercise managerial authority or bind the partnership in contracts and in other ways; and (9) whether any persons, other than the limited partners, exercised managerial authority, or held the authority to bind the partnership in contracts and in other ways.
[l] Quoting H.R. Rep. No. 95-702, pt. 1 (1977).
[li] Denham Capital Management appealed to the 1st Circuit in April 2025 (No. 25-01349); Sirius appealed to the 5th Circuit (May 2024) (No. 24-60240), which heard oral argument in Feb. 2025.
[lii] Golsen v. Comm’r, 54 T.C. 742 (1970), aff’d on other grounds, 445 F.2d 985 (10th Cir. 1971), cert. denied, 404 U.S. 940 (1971).
[liii] Individuals who provide services in certain service partnerships will not be treated as limited partners.
[liv] Query, in any case, whether the proposed regulations would survive in today’s post-Chevron Doctrine environment.
[lv] As in the case of Soroban and the Principals.
[lvi] Meaning, they do not acquire an interest in the capital contributed by other partners; the latter’s contributions of cash or other property are credited to their own capital accounts, which are adjusted in accordance with the regulations under IRC Sec. 704.
[lvii] Rev. Rul. 69-184. This is also why the IRS has not required partnerships to pay reasonable compensation to service partners.
[lviii] Except to the extent the partnership generates types of income that are excluded from self-employment taxes, including capital gains, interest, and dividends. See also General Explanations of the Administration’s Fiscal Year 2024 Revenue Proposals, pg. 140. https://home.treasury.gov/system/files/131/General-Explanations-FY2024.pdf.