Denham Capital Management LP (“Denham”), a private equity firm, has appealed the recent U.S. Tax Court decision that declined to revisit its interpretation of the “limited partner exception” under the Self-Employment Contributions Act (“SECA”).
As discussed previously, the Tax Court held that a partner’s status as a limited partner under state law does not control whether the partner qualifies for the limited partner exception to the SECA tax. Code Section 1402(a)(13) states that the distributive share of partnership income allocable to a “limited partner, as such,” is generally not subject to self-employment tax. The statute, however, does not define “limited partner,” which has led to ongoing legal disputes between the IRS and various investment management companies formed as limited partnerships.
In December 2024, the Tax Court sided with the IRS, ruling that Denham’s limited partners were not mere passive investors. Instead, the Tax Court applied a “functional analysis” to determine that Denham’s five limited partners performed substantial services for the firm, which rendered them functionally akin to general partners or employees whose income was subject to the self-employment tax under SECA. This ruling reaffirmed the Tax Court’s position in a 2023 case involving the same issue for Soroban Capital Partners LP.
Denham’s appeal echoes a similar appeal by Sirius Solutions L.L.L.P. in the Fifth Circuit, which heard oral arguments in February 2025. If the First Circuit and the Fifth Circuit reach different conclusions, the resulting circuit split may invite the Supreme Court to resolve the issue. We will continue to monitor developments in these cases and provide updates as the limited partner exception to SECA tax continues to be litigated.
