The 2021 draft instructions for Form 1065 have added additional information related to a determination of whether a taxpayer has self-employment income from the partnership.[1]

The new revision to the instructions provides:

However, whether a partner (including a member of an LLC treated as a partnership for federal income tax purposes) qualifies as a limited partner for purposes of self-employment tax depends upon whether the partner meets the definition of a limited partner under section 1402(a)(13); whether a partner is a limited partner under state limited partnership law is not determinative. Relevant to this determination is whether the partner merely invested in the partnership and is not actively participating in the partnership’s business operations; a partner who is performing services for a partnership in their capacity as a partner and that is, based on the facts and circumstances, acting in the manner of a self-employed person is not a limited partner for self-employment tax purposes. See Renkemeyer, Campbell & Weaver, LLP v. Commissioner, 136 T.C. 137, 150 (2011).[2]

Advisers that have not previously studied the Renkemeyer decision should definitely look that one over, as well as look at the application of that decision to a less aggressive attempt to avoid self-employment tax in the Castigliola case.[3]

While the IRS mentions that a determination whether a partner is a limited partner under state law is not determinative, those cases deal rather with the treatment of an LLP or LLC member. Presumably the IRS would also extend the analysis in those cases to a partner in a true limited partnership that holds both a standard general partnership interest and a limited partnership interest, especially in a case where there are no individuals who are limited partners only with interests with the same rights as those of the limited interest held by the general partner.

[1] “2021 Instructions for Form 1065,” Draft as of November 24, 2021, https://www.irs.gov/pub/irs-dft/i1065--dft.pdf (retrieved November 26, 2021)

[2] “2021 Instructions for Form 1065,” Draft as of November 24, 2021, p. 39

[3] Castigliola, et al v. Commissioner, TC Memo 2017‑62, April 12, 2017, https://www.taxnotes.com/research/federal/court-documents/court-opinions-and-orders/distributive-shares-not-excludable-from-self-employment-income/nn43?h=castigliola (retrieved November 26, 2021), Edward Zollars, “Law Firm Members Not Allowed to Treat Income in Excess of Reasonable Compensation Guaranteed Payments as Not Self-Employment Income”, Current Federal Tax Developoments website, April 12, 2017, https://www.currentfederaltaxdevelopments.com/blog/2017/4/12/law-firm-members-not-allowed-to-treat-income-in-excess-of-reasonable-compensation-guaranteed-payments-as-not-self-employment-income (retrieved November 26, 2021)