Limited Partner Self-Employment Tax After Soroban: Fund Managers

Do limited partners pay self-employment tax after Soroban?

Under Soroban, partners who run, manage or control the management company generally owe self-employment tax on their fee profit shares. Limited liability and a state-law limited-partner title do not establish the exception. The Second Circuit affirmed tax on the principals' profit shares (Soroban opinion, pages 30 and 56–59).

This question also arises for LLCs and LLPs taxed as partnerships; the IRS campaign covers all three forms (IRS active campaigns). The Soroban principals worked full time, served on governing committees and participated in hiring and firing. Paying tax on their guaranteed payments did not exempt the rest of their management-company earnings.

The Second Circuit issued Soroban on September 17, 2026. That opinion described Denham as pending in the First Circuit, with jurisdiction and the merits at issue. Later appellate decisions or orders may change the applicable analysis.

Appeal venue means the federal appeals court that would review a Tax Court decision. For partnership-level petitions under section 6234, venue generally follows the partnership's principal place of business when the petition is filed. For an individual partner's own Tax Court case, venue generally follows the partner's legal residence when the petition is filed (section 7482(b)(1)(A)). This includes valid election-out cases (section 6221(b)). The centralized partnership audit rules (BBA) cover income tax only: the IRS can also adjust self-employment tax outside a BBA proceeding, but relevant BBA determinations must be taken into account (26 CFR 301.6241-6(a)(1)). Delaware formation does not determine either venue; the IRS and taxpayer can designate another circuit by written agreement (section 7482(b)). Confirm the proceeding and venue for each year.

Which test applies in New York, Texas, California, Florida or Massachusetts?

The controlling appeals court matters, but neither published appellate test gives a blanket exclusion to active managers. Determine the applicable appeal venue before using this comparison; a partner's own case can go to a different circuit from the firm's.

The Fifth Circuit replaced its earlier opinion on August 12; the substitute opinion supplies its test. Soroban considered the tests close and said its principals would fail the Fifth Circuit test too (Soroban, pages 56–57). The significance of a limited role remains fact-dependent.

Can a capital-only partner, retired founder or investment committee member qualify?

A partner who invests without managing may qualify, but review each partner separately. Soroban allows some services that do not amount to running, managing or controlling the business and notes that other limitations may vary by state (Soroban, page 30, note 10, and page 57).

Qualifying retirement payments have a separate exclusion under section 1402(a)(10). All these conditions must be met:

• A written partnership plan provides genuine retirement income to partners generally or a class of partners, paid at regular intervals and continuing at least until death.
• The recipient performs no services for any business of the partnership or its successors during the relevant partnership tax year.
• The recipient's partnership capital has been paid back in full by that year-end.
• At that year-end, the other partners owe the recipient nothing in their capacity as partners except the plan's retirement payments and permitted health and death benefit rights.

A retired founder who still advises the firm cannot assume this exclusion applies (retirement-payment regulation).

Does self-employment tax reach incentive allocations and capital returns?

Management-company service earnings and fund investment allocations need separate analysis. Losing the limited partner exception does not remove the statutory exclusions for qualifying investment income.

These exclusions follow section 1402(a). The Form 1065 instructions also say a partnership solely operating a group investment program generally has no self-employment earnings for general or limited partners. A management company charging advisory fees is a separate business.

Calling management profits a return on contributed capital, or calling a service fee an incentive allocation, does not establish an exclusion. Trace the payment to the entity earning it and the underlying tax item.

Carry from a trading fund can be subject to net investment income tax even when excluded from self-employment tax. A capital-only partner's fee share may also be subject to that tax if the partner does not materially participate, even when the limited partner exception applies. Income included in self-employment earnings is generally excluded (Form 8960 instructions). The holding-period question belongs in the carried interest guide.

What changes in K-1 box 14 and each partner's Schedule SE?

If a management partner does not qualify for the exception, the partnership should include that partner's taxable fee profit share in box 14, code A, alongside taxable guaranteed payments. Each individual partner uses the amount in Schedule SE, with applicable partner-level adjustments (Form 1065 instructions, Schedule SE instructions).

Work in this order:

1. Identify the applicable appeal venue and each partner's actual responsibilities.
2. Separate ordinary service earnings from excluded investment items.
3. Prepare the partnership's self-employment earnings worksheet and box 14 reporting.
4. Give each partner the calculation and supporting statements. Do not add guaranteed payments twice if box 14 already includes them.
5. Calculate each partner's Schedule SE and, where required, Form 8959 using that partner's wages, other self-employment earnings and filing status.

Box 14 is not the final tax base after the Schedule SE earnings adjustment. The partner applies that adjustment on Schedule SE. Reclassifying income as self-employment earnings also does not create a second amount of ordinary income.

A BBA partnership is one subject to the IRS's centralized partnership audit rules. Check whether the firm validly elected out for the tax year. A partner reporting an item differently from a BBA partnership generally files Form 8082 with their return and explains the difference. Partners in partnerships that validly elected out cannot use that form. An inconsistent-treatment notice also cannot be filed after the BBA partnership receives a notice opening an administrative proceeding (Form 8082 instructions).

A partner disagreement does not itself extend filing or payment deadlines. An unresolved difference may require an eligible inconsistent-treatment notice; disclosure alone does not establish that the position is correct. We prepare management-company and GP returns and K-1s, including box 14, and partners' returns with Schedule SE and any required Form 8959: see hedge fund tax and accounting.

For general partnership taxation, see how partnerships are taxed.

How much additional tax can each partner owe?

The extra tax depends on earnings already subject to Social Security tax and whether the partner has crossed the Additional Medicare Tax threshold. The full self-employment tax rate does not apply to every additional fee dollar.

Schedule SE generally multiplies taxable net profit by 92.35%. Social Security tax is 12.4% up to the annual $184,500 base, reduced by covered wages; Medicare tax is 2.9% without that cap (Schedule SE, SSA wage base). Guaranteed payments already included in self-employment earnings use the same annual base as the newly included profit share. Each spouse has a separate Social Security calculation.

Additional Medicare Tax is 0.9% above the applicable threshold. Medicare wages and self-employment income are combined, including both spouses' amounts on a joint return (Form 8959 instructions).

Half the regular Social Security and Medicare self-employment tax is an income-tax deduction. Additional Medicare Tax is excluded from that deduction (section 164(f)). A deduction reduces taxable income; it is not a dollar-for-dollar refund of the tax.

Example

Illustrative amounts in US dollars. An individual partner runs a New York management LP, receives a $400,000 guaranteed payment for services and a $1,000,000 share of ordinary fee profits, and previously excluded the profit share. Assume the Second Circuit's test applies, no other earnings or partner-level adjustments, and no net investment income tax on this active management income.

The partner fails the Soroban test. The guaranteed payment already produces $369,400 of self-employment earnings after the 92.35% adjustment. That exceeds the $184,500 Social Security base and every applicable Additional Medicare Tax threshold. Including the fee share adds:

Box 14, code A, generally increases from $400,000 to $1,400,000 before partner-level adjustments. The added Schedule SE base is $923,500. The final income-tax effect depends on the partner's other deductions and tax circumstances; the $8,311.50 Additional Medicare Tax has no half-tax deduction.

If all business earnings are allocated to New York City, the fee share also bears $5,541 of commuter transportation tax: $923,500 × 0.60%. Federal taxes plus this state tax attributable to the share total $40,634 before income-tax effects. New York's own active-partner rule can require this tax even when the federal exception was claimed (New York definitions, estimated tax instructions).

Should we correct earlier returns, wait or retain the position?

Review each open year separately; a change on the current return does not resolve earlier exclusions. The IRS lists an active self-employment tax campaign targeting partners who incorrectly claim limited partner status, including service partners in LPs, LLPs and LLCs (IRS active campaigns).

Interest and penalties can accompany an underpayment. The accuracy-related penalty is generally 20% of the affected underpayment when statutory grounds apply; reasonable cause and good faith may provide relief, subject to exceptions (sections 6662 and 6664). For the substantial-understatement ground, substantial authority or adequate disclosure with a reasonable basis can reduce the understatement; tax-shelter items are excepted (section 6662(d)(2)). Where required, the entity or partner discloses on Form 8275 with the return, or Form 8275-R for a position contrary to a regulation (disclosure instructions). A disputed legal issue does not guarantee relief.

Self-employment tax is each individual partner's liability under section 1401. A partnership AAR or imputed underpayment does not pay it: BBA covers income tax only, and each partner must account for the self-employment tax for the affected year (26 CFR 301.6241-6). For pushed-out adjustments, report self-employment tax changes on Form 1040-X for the first affected year, with a calculation and source statement; Form 8978 handles income tax only (Form 8978 instructions).

BBA partnerships generally correct partnership items through an administrative adjustment request (AAR), due 3 years from the later of filing or the unextended due date, generally barred after a notice opening an administrative proceeding; other partnerships generally amend, and correcting a filed business return explains the procedures and partner adjustments (IRS AAR guidance).

Do partners need bigger estimated payments now?

Partners may need larger estimated payments when their fee shares become self-employment earnings. Recalculate the full federal liability, including regular self-employment tax and Additional Medicare Tax, then compare it with withholding and payments already made; estimated tax covers self-employment tax as well as income tax (IRS estimated taxes). Safe-harbor and uneven-income methods are in estimates for fund K-1 income.

Would guaranteed payments or S corporations reduce the tax?

Guaranteed payments for services remain self-employment earnings, so replacing a taxable profit share with those payments does not itself remove the tax (section 1402(a)(13)); compare partner payment methods in paying yourself. A management-company or partner-level S corporation changes the analysis, but a working shareholder must receive reasonable compensation subject to employment taxes before taking non-wage distributions (IRS compensation guidance). Corporate ownership does not retroactively fix earlier individual-partner reporting; review eligibility and ongoing costs in whether a fund management company should be an LLC or an S corporation.

Can taxable earnings support larger retirement contributions?

Reclassified management earnings may increase earned income available for retirement contributions, subject to the plan's limits and terms. More taxable earnings do not automatically create more contribution room if the partner already reaches a limit.

Publication 560 excludes a qualifying limited partner's ordinary distributive share from plan earnings but includes service guaranteed payments. When the share instead qualifies as self-employment earnings from services, review it in the plan calculation. The calculation accounts for the deductible part of self-employment tax and the partner's own plan contributions; capital gains are excluded.

Different for you?

• Nonresident status or foreign social security coverage: nonresident aliens generally fall outside US self-employment tax, subject to international agreement rules; an agreement can also exempt earnings covered exclusively by another country's system (sections 1402(b) and 1401(c)). See self-employment tax for nonresidents; bring residency and coverage records to hedge fund tax and accounting.
• Earlier exclusions, an IRS letter or a partner dispute: request a review through hedge fund tax and accounting before choosing a correction or return position. Gather partnership agreements, committee charters and minutes, descriptions of actual duties, prior K-1s and returns, wage statements and IRS notices.
• Box 14 needs review before March 15: use hedge fund tax and accounting. Calendar-year partnerships generally file by March 15, subject to extensions and weekend or holiday adjustments; a late or incomplete return can bring a penalty of $260 per partner per month or part-month, for up to 12 months, unless reasonable cause applies (Form 1065 instructions, Revenue Procedure 2025-32, sections 4.55 and 4.58). An incorrect K-1 can separately bring the general penalty of $340 per statement; correction timing and reasonable cause can reduce or remove it, while intentional disregard increases it.
• Business activity is in New York City or nearby counties: New York applies its own active-partner test for commuter transportation tax (MCTMT). If earnings allocated to a zone exceed $150,000 per individual, the tax applies to the whole zone amount: 0.60% in New York City and 0.34% in Zone 2 (Nassau, Suffolk, Westchester, Rockland, Orange, Putnam and Dutchess). Request the partnership's zone allocations (New York definitions, estimated tax instructions).
• The partnership has already filed: follow correcting a filed business return.
• Your allocation is investment carry: use the carried interest guide for the holding-period and reporting rules.
• You are considering a corporate structure: start with whether a fund management company should be an LLC or an S corporation.
• Partner health insurance changes the calculation: see health insurance for owners.