General Partner vs. Limited Partner: Which One Owes Self-Employment Tax on the K-1? (2026)

Published: August 27, 2026 · Reading time: 11 min

TL;DR: IRC §1402(a)(13) excludes a limited partner's distributive share from self-employment tax, while a general partner's share is always subject to it. The trap: the IRS's own attempt to define "limited partner" objectively was blocked by a congressional moratorium in 1997 and never revived, so the Tax Court has decided the question case by case ever since. Renkemeyer (2011) set the pattern, and two decisions roughly 14 months apart — Soroban (merits decided 2025) and Denham Capital (2024) — applied it most recently, all holding that a state-law "limited partner" or "limited member" designation doesn't control if the partner actually works in the business. A freelancer pair who label the less-hands-on founder a "limited member" to save 15.3% SE tax can lose that savings entirely on audit — and owe it back, with interest — if that founder's real involvement looks anything like full-time.

Two freelance consultants form an LLC together, taxed as a partnership. One runs client delivery day-to-day; the other contributes capital and occasional strategic advice. Their operating agreement designates the second founder a "limited member" with no management authority, partly to keep their 50% share of partnership income out of self-employment tax. That structure might work exactly as intended — or it might not survive an audit, and the difference has nothing to do with what the operating agreement says.

The Statute: A Real Exclusion, With One Carve-Out Built In

IRC §1402(a)(13) provides the exclusion:

"There shall be excluded the distributive share of any item of income or loss of a limited partner, as such, other than guaranteed payments described in section 707(c) 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."

Two things to notice immediately. First, the exclusion only reaches a limited partner's distributive share "as such" — meaning, in their capacity as a passive capital-holder, not in any other capacity. Second, guaranteed payments for services are carved out by name. A guaranteed payment under IRC §707(c) is compensation fixed without regard to whether the partnership actually made money — and no matter how passive a partner's capital interest is otherwise, a guaranteed payment for services they actually performed is always subject to self-employment tax. The limited-partner exclusion was never designed to shelter compensation for work; it shelters a return on capital.

The Problem: Nobody Ever Defined "Limited Partner" for This Purpose

Here's where this gets genuinely unusual as tax questions go. In 1997, the IRS proposed a regulation — Prop. Reg. §1.1402(a)-2, 62 Fed. Reg. 1702 — that would have defined "limited partner" for §1402(a)(13) using three objective tests: no personal liability for partnership debts, no authority to enter contracts on the partnership's behalf, and no more than 500 hours of work in the business per year.

Congress didn't let it happen. The Taxpayer Relief Act of 1997 (Pub. L. 105-34, §935) imposed a moratorium barring the IRS from finalizing any regulation on this specific topic through July 1, 1998. The IRS never went back to it. Nearly three decades later, there is still no regulation defining "limited partner" for self-employment tax purposes — which means the question has been left entirely to case-by-case litigation.

The Case Law: A State-Law Label Proves Nothing

Three decisions, spanning 14 years and converging on the same answer, fill the gap left by the missing regulation.

Renkemeyer, Campbell & Weaver, LLP v. Commissioner, 136 T.C. 137 (2011). Active, practicing lawyer-partners at a Kansas law firm held interests denominated as "limited partnership interests" under state LLP law, with limited liability. The Tax Court held they were not limited partners for §1402(a)(13) purposes. Its reasoning looked past the state-law label to the statute's legislative history, which aimed the exclusion at earnings "of an investment nature" — and the partners' distributive shares came from the legal services they personally performed for clients, not from a passive return on capital, so the state-law liability shield proved nothing about whether their role was actually passive.

Soroban Capital Partners LP v. Commissioner, 161 T.C. No. 12 (2023), decided on the merits at T.C. Memo. 2025-52. A hedge fund's partners held state-law "limited partner" interests while working full-time managing the fund. The Tax Court applied what's now called the "functional analysis test": state-law designation is not controlling; the real inquiry looks at time devoted to the business, participation in management, capital contributed, and how central the partner's own skill and judgment is to generating the partnership's income. The result: the fund's SE income was increased by $77,663,963 for 2016 and $63,866,302 for 2017 — the partners' full distributive shares, previously excluded as "limited partner" income, were reclassified as subject to self-employment tax.

Denham Capital Management LP v. Commissioner, T.C. Memo. 2024-114. The first case to apply Soroban's functional test on similar facts: partners holding state-law "limited partner" interests who worked full-time in the business were found to be "limited partners in name only," and their distributive shares were likewise reclassified.

The pattern across all three: a state-law label is evidence, not proof. What actually decides the question is whether the partner functions as an active participant or a passive investor — hours worked, authority exercised, and whose skill is actually generating the income.

Worked Example: The Same $75,000, Two Possible Outcomes

Two freelance creatives form "Studio Co LLC," taxed as a partnership, with $150,000 of net ordinary business income for 2026 remaining after Partner B's guaranteed payment (below) is paid out, split 50/50 by their operating agreement — $75,000 each.

Partner A — Managing Member. Runs client relationships and delivery full-time; unambiguously active. Their $75,000 distributive share is SE income regardless of any label — the §1402(a)(13) exclusion was never designed to reach an active general partner's share in the first place.

Partner B — designated "Limited Member." Also receives a $20,000 guaranteed payment for ongoing creative-direction consulting, plus the identical $75,000 distributive share.

The $20,000 guaranteed payment is SE income no matter what — §1402(a)(13)'s own text carves guaranteed payments for services out of the exclusion entirely.

But if Partner B actually works 20+ hours a week on client accounts — a fact pattern close to the full-time "limited" partners in Denham — a court or an IRS exam applying the functional test would find the label doesn't hold up, and would add the $75,000 distributive share back into SE income too:

The reclassification costs exactly $10,597.16 — the identical SE tax Partner A pays on the identical $75,000 share. The label never changed the underlying dollar amount at stake; it only changed whether Partner B paid that tax now, voluntarily, or paid it later — after an exam, plus interest, and potentially a §6662 accuracy-related penalty if the original position had no reasonable basis.

What Actually Determines the Answer

No single factor is dispositive, and there is no safe-harbor hour count — the one bright-line test the IRS ever proposed (500 hours/year) never became binding law. A freelancer pair structuring a partnership around this exclusion is making a facts-and-circumstances bet, not relying on a rule.

Quick Reference

Frequently Asked Questions

Does calling myself a "limited partner" or "limited member" in my operating agreement exempt my share of partnership income from self-employment tax?

Not on its own. IRC §1402(a)(13) excludes a limited partner's distributive share from net earnings from self-employment, but the IRS has never finalized a regulation defining what makes someone a limited partner for this purpose — a 1997 proposed regulation with objective tests (no personal liability, no contract authority, 500 hours or fewer per year) was blocked by a congressional moratorium in the Taxpayer Relief Act of 1997 and never revived. In its absence, the Tax Court has applied a facts-and-circumstances "functional test" in three recent decisions — Renkemeyer (2011), Soroban (2023/2025), and Denham Capital (2024) — all holding that a partner who actually works in the business, regardless of the state-law label on their interest, is not a limited partner for this exclusion. The label in your operating agreement is evidence, not proof.

What is the functional test courts use to decide if someone is really a limited partner for self-employment tax purposes?

Courts look at the partner's actual role rather than their state-law designation: how much time they devote to the business, whether they participate in management, how much capital they contributed relative to their labor, and how important their personal skill and judgment is to generating the partnership's income. In Soroban Capital Partners LP v. Commissioner and Denham Capital Management LP v. Commissioner, partners who were designated "limited partners" under state law but worked full-time in the business were found not to qualify for the §1402(a)(13) exclusion — their full distributive shares were subject to self-employment tax, generating enormous back-tax exposure in Soroban's case (over $140 million in reclassified income across two years).

Are guaranteed payments to a limited partner ever excluded from self-employment tax?

No — this exclusion never reaches guaranteed payments, regardless of how passive the partner is otherwise. IRC §1402(a)(13) excludes a limited partner's distributive share "other than guaranteed payments described in section 707(c) to that partner for services actually rendered." A guaranteed payment is compensation fixed without regard to partnership income, and the statute carves it out of the limited-partner exclusion by name. A partner who is genuinely passive with respect to their capital-based distributive share, but who also receives a guaranteed payment for consulting or advisory services, owes self-employment tax on that guaranteed payment no matter what.

Why did the IRS never finalize its own definition of "limited partner" for self-employment tax purposes?

The IRS proposed a definition in 1997 (Prop. Reg. §1.1402(a)-2, 62 Fed. Reg. 1702) using three objective tests — no personal liability for partnership debts, no authority to contract on the partnership's behalf, and no more than 500 hours of work in the business per year. Congress reacted by imposing a moratorium in the Taxpayer Relief Act of 1997 (Pub. L. 105-34, §935), barring the IRS from finalizing any regulation on this topic through July 1, 1998. The IRS has never revisited it since, leaving nearly three decades without a governing regulation and forcing the question to be litigated case by case in the Tax Court instead.

If I structure my freelance partnership with a "limited member" to save on self-employment tax, what's the actual risk?

The risk is that the label saves nothing if it doesn't match reality, and the exposure surfaces later rather than never. If the designated "limited member" genuinely devotes significant time to the business or participates meaningfully in management, an IRS exam applying the Soroban/Denham functional test can recharacterize their full distributive share as self-employment income — producing the same self-employment tax that a general partner would have owed on that share, plus interest, and potentially an accuracy-related penalty under §6662 if the position lacked a reasonable basis. There is no safe-harbor hour count to rely on, because the one bright-line test the IRS proposed (500 hours) never became binding law.

Authoritative References

• 26 U.S.C. §1402 — Definitions
• 26 U.S.C. §707 — Transactions between partner and partnership
• Soroban Capital Partners LP v. Commissioner, 161 T.C. No. 12 (2023)
• Renkemeyer, Campbell & Weaver, LLP v. Commissioner, 136 T.C. 137 (2011)
• IRS Schedule SE Instructions

Related reading: Schedule C vs. Form 1065: Sole Proprietor or Partnership? · Schedule SE: Self-Employment Tax Explained · How to Lower Your Self-Employment Tax · Single-Member LLC and Schedule C

The Records That Back Up How a Partnership Actually Runs

If a "limited member" designation is ever tested, the facts that matter — who actually did the work, whose name is on client-facing expenses, who traveled for the business — live in your day-to-day records, not your operating agreement. CentSense keeps every receipt and mileage log tied to the person and the purpose behind it, so your partnership's real operating pattern is documented as it happens. Free tier includes 10 AI scans per month; Solo is $5/month for unlimited scanning and mileage logging.

Start free →

This guide is general education for U.S. freelancers structuring or operating a multi-member LLC or partnership. It is not personalized tax or legal advice. Whether a specific partner qualifies as a limited partner under IRC §1402(a)(13) is a fact-specific determination with no governing regulation and significant litigation risk. Consult a CPA, EA, or tax attorney before relying on this exclusion.