IRS Concludes That Partners in Investment Management LLC Are Subject to Employment Tax
The IRS recently released an internal legal memorandum (CCA 201436049), which concluded that partners in a limited liability company, taxed as a partnership that provides investment management services to a family of investment partnerships, are required to pay self-employment taxes on their distributive share of the partnership's income.
The Management Company treated all of its partners as limited partners and only treated the guaranteed payments made to such partners as subject to self-employment tax. The Management Company succeeded an S corporation that provided similar services to the Funds, and which also only paid wages to its shareholder employees that were equal to the cost of health insurance premiums and parking fees.
The investment management company ("Management Company") was a general partner in several managed funds ("Funds") treated as partnerships, and received a quarterly fee for its services based on a percentage of the assets under management by the Funds. The Management Company had full authority and responsibility to manage and control the affairs and business of each Fund, including carrying out the market research and trading activity of each of the Funds. Each Fund also had a second general partner (the "Profits GP") who did not take part in the day-to-day conduct of the Fund's business, but received a substantial interest in each Fund's profits and gains. The Profits GP was not the subject of the IRS advice.
Each partner in the Management Company worked full time for the Management Company and provided a wide variety of professional services, including analyst services, trading services, portfolio management services, and tax, accounting and administrative activities. Each partner was paid wages equal to guaranteed payments representing health insurance premiums and parking benefits paid by the Management Company on behalf of the partner. The partners, who acquired their interests upon contribution of capital to the Management Company, were also allocated a distributive share of the Management Company's taxable income, including ordinary income attributable to the management fees. The Management Company also had employees who were not partners and who were paid market-rate wages. The Management Company treated all of its partners as limited partners and only treated the guaranteed payments made to such partners as subject to self-employment tax. The Management Company succeeded an S corporation that provided similar services to the Funds, and which also only paid wages to its shareholder employees that were equal to the cost of health insurance premiums and parking fees.
Self-employment taxes are generally imposed on the gross income derived by an individual from any trade or business, including the distributive share of any trade or service performed by a partnership of which such individual is a partner. However, under the Code, self-employment taxes are not imposed on the distributive share of a "limited partner" of a partnership other than guaranteed payments to the limited partner for services actually rendered to or on behalf of the partnership. The IRS noted that the relevant Code provision was enacted in 1977, prior to the time when limited liability companies were widely used, and the term "limited partner" is not defined in the relevant statute. Relying on a 2011 Tax Court case, Renkemeyer, Campbell and Weaver LLP v. Commissioner (136 T.C. 137), which held that practicing lawyers in a Kansas limited liability partnership were not "limited partners" for purposes of the self-employment tax, the IRS ruled that the partners in the Management Company were not "limited partners" because the taxable income of the Management Company was derived from extensive investment services and operational management services performed by the partners and not income that is basically of an investment nature.
See: CCA 201436049.For more information, please contact Daniel Mulcahy or Mark Howe.