Hi,
If you’re a partner in an LP, LLP, or LLC and you’ve been treating your share of the profits as exempt from self-employment tax, that position is under direct attack, and the amount at stake is 15.3% of your distributive share.
The old rule felt simple: a limited partner’s distributive share is exempt from SE tax under Section 1402(a)(13). Not anymore. The IRS now ignores the label on your K-1 and looks at what you actually do. Work in the business day to day and the Tax Court calls you a “limited partner in name only,” which pulls your whole distributive share into self-employment income. That’s exactly how the fund principals in the Soroban cases lost.
Here’s what actually decides it, because it isn’t the entity you chose.
- A functional analysis, not a title. The court looks at your real role: how much of the firm’s income you generate, whether you manage people and sit in meetings, how many hours you put in, and whether your capital is small next to your profit share. Active on those and the exception is gone.
- Guaranteed payments were never safe. Payments for your services are subject to SE tax no matter what. The fight is only over the distributive share on top, which is where the real money is.
- Where you are matters right now. In January 2026 the Fifth Circuit (Texas, Louisiana, Mississippi) rejected the functional test and said state-law limited liability is enough. Everywhere else, the IRS and Tax Court are still applying the functional test and assessing. Two more appeals land in 2026 that could split the courts further.
The last point is the whole reason to act now. The law is unsettled and fact-specific, which means your exposure depends on your role, your documentation, and your circuit, not on a form you filed years ago. If the IRS opens your partnership, the question is whether you have a defensible written position already on file.
We developed a specific process under one roof, built around defending and optimizing your partner-level position:
- Technical memos. A written functional analysis for each partner, documenting roles, hours, capital, and management, so your SE tax position is supported before anyone asks.
- Tax strategy. Structuring the split between guaranteed payments and distributive share, entity and compensation design, and reasonable-comp positioning to minimize exposure without inviting a challenge.
- Monthly bookkeeping. A dedicated bookkeeper and a full financial discussion each month, so the numbers behind the memo are clean and current.
- Fractional CFO. Year-round review of partner compensation, cash flow, and distributions, so the structure keeps working as your business grows and the case law evolves.
Why starting now matters: you still have most of 2026 left to put a real, documented position in place. Wait until year-end and you’re out of runway.
Reply to this email by next Friday and we’ll set up a free 15-minute call with our COO and Tax Strategist, Liliya Maksimov. Bring your partnership agreement and last K-1 so we can pressure-test where you stand and what a defensible position is worth to you.
Sincerely,
—
George Dimov, CPA
Licensed and Insured
(833) 829-1120 toll free
(212) 994-8081 Fax
www.dimovtax.com