Not every business owner who receives a K-1 pays self-employment tax the same way. Whether a business is structured as a general partnership, a limited partnership, or an LLC taxed as a partnership changes who owes the 15.3% self-employment tax on their share of the profit – and a 2025 Tax Court ruling narrowed one of the main exceptions significantly.
The Default Rule for General Partners
A general partner’s distributive share of partnership income is subject to self-employment tax in full, because general partners bear personal liability for the partnership’s debts and are treated as actively engaged in the business by definition. There’s no exception available to a true general partner regardless of how much or how little time they actually spend working in the business.
The Limited Partner Exception – and Its Limits
Section 1402(a)(13) of the tax code excludes a limited partner’s distributive share from self-employment tax, on the theory that a limited partner is a passive investor rather than someone actively working in the business – with one carve-out that guaranteed payments for services a limited partner actually performs are still subject to SE tax even if their remaining distributive share isn’t.
Soroban Capital: Being “Limited” on Paper Isn’t Enough
In 2025, the U.S. Tax Court ruled against the partners of Soroban Capital Partners, a hedge fund manager, holding that the Section 1402(a)(13) exception requires a functional analysis of what a partner actually does – not just their state-law label. The court found that partners who worked full-time, exercised managerial control, served on key committees, and had authority to bind the partnership were not functioning as limited partners no matter what their partnership agreement called them, and their full distributive share was subject to self-employment tax.
Why This Matters for LLC Members Too
An LLC taxed as a partnership doesn’t have “general” or “limited” partners in the state-law sense – all members have limited liability by default – which historically created ambiguity about whether LLC members could claim the Section 1402(a)(13) exception at all. The IRS and courts have generally applied the same functional, facts-and-circumstances test to LLC members: an active, managing member is treated like a general partner for SE tax purposes regardless of the LLC label, while a genuinely passive investor-member has a stronger case for the exception.
The Practical Takeaway
Simply forming an LLC or drafting a partnership agreement that labels someone a “limited partner” or “non-managing member” no longer settles the self-employment tax question on its own, post-Soroban. What actually matters is whether the owner is doing real, active work for the business – hours worked, management authority, and whether their income looks like compensation for services versus a return on capital investment. Owners relying on the limited partner exception should document their actual role and time commitment, not just their title, since that documentation is exactly what the IRS and Tax Court now look at first.
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Related reading: Multi-Member LLC Operating Agreements and Tax Elections and Self-Employment Tax and Entity Choice.
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