Self-Employment Tax for LLC Members and Partners

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Section 1402(a)(13) excludes from self-employment income “the distributive share of any item of income or loss of a limited partner, as such,” other than guaranteed payments for services. It was written in 1977 for passive investors in limited partnerships. LLCs did not exist. Forty-nine years later, every multi-member LLC taxed as a partnership faces the same question: are the members “limited partners” for this purpose, and the answer determines whether 15.3% (then 2.9%, then 3.8%) applies to their share of the profit.

The IRS proposed regulations in 1997 and Congress froze them. Since then the Tax Court has filled the gap case by case, and the direction is consistent: a member who works in the business owes the tax on the share attributable to that work, whatever the state-law label. This page is the current state of the law and the desk procedure for applying it.

Step 1: What Is Self-Employment Income from a Partnership

• Included (§1402(a)): the partner’s distributive share of income or loss from any trade or business carried on by the partnership, plus guaranteed payments for services or capital (§707(c)).
• Excluded regardless of partner status: rentals from real estate (unless a dealer or substantial services are provided, §1402(a)(1)); dividends and interest (§1402(a)(2)) unless the partnership is a dealer; gains from the sale of capital assets and §1231 property (§1402(a)(3)); retired partner payments meeting §1402(a)(10).
• Guaranteed payments for services are always SE income, to every partner including a limited partner (§1402(a)(13), the carve-out from the carve-out). Guaranteed payments for the use of capital are SE income to a general partner and excluded for a limited partner.
• SE income is computed on the partner’s own return (Schedule SE) from the K-1 box 14 code A figure, which the partnership computes; the partner is not bound by the partnership’s classification, and the IRS is not bound by either.
• Rates for 2026: 12.4% Social Security to the wage base ($184,500 (verify)), reduced by any W-2 wages the partner has elsewhere; 2.9% Medicare on everything; 0.9% additional Medicare above $200,000 / $250,000 joint. Half of the SE tax is an above-the-line deduction (§164(f)), and the §1402(a)(12) 92.35% factor applies.

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Step 2: The Limited Partner Exception

The statute excludes the distributive share of “a limited partner, as such.” It does not define the term. State law defines limited partners of limited partnerships, but says nothing about LLC members, LLP partners, or general partners who happen to be passive.

Prop. Reg. §1.1402(a)-2(h) (1997) would have treated a partner as a limited partner unless any of three things is true: (1) personal liability for partnership debts by reason of being a partner; (2) authority under state law to contract on behalf of the partnership; or (3) participation in the partnership’s trade or business for more than 500 hours during the year. A service partner in a service partnership (health, law, engineering, architecture, accounting, actuarial science, consulting) could never be a limited partner. The proposal also allowed a partner holding two classes of interest to bifurcate. Congress responded with a one-year moratorium in the Taxpayer Relief Act of 1997 (§935), the regulations were never finalized, and the IRS has said it will not challenge a taxpayer who follows them. They are not law, but they are the most concrete guidance that exists, and the Tax Court’s cases have landed near where they point.

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Step 3: The Cases

Case	Facts	Holding
Renkemeyer, Campbell & Weaver, LLP v. Commissioner, 136 T.C. 137 (2011)	Three lawyers in an LLP, each a “limited partner” under Kansas law, allocated the firm’s profits	The exception is for investors, not for partners whose income derives from legal services. Legislative history controls over the state-law label. SE tax on all of it.
Riether v. United States, 919 F. Supp. 2d 1140 (D.N.M. 2012)	Husband and wife LLC members paid themselves W-2 wages and treated the rest as not subject to SE	Partners cannot be employees of their own partnership; the entire distributive share is SE income; the W-2s were wrong too.
Castigliola v. Commissioner, T.C. Memo 2017-62	Three lawyers in a Mississippi PLLC, member-managed, paid themselves “guaranteed payments” equal to a reasonable salary and excluded the remaining profit	Members with management authority are not limited partners; the entire distributive share is SE income.
Soroban Capital Partners LP v. Commissioner, 161 T.C. No. 12 (2023) (Soroban I)	A Delaware limited partnership (hedge fund manager) with state-law limited partners who worked full time	“Limited partner, as such” requires a functional analysis; the state-law label is not enough. Reviewed opinion.
Soroban Capital Partners LP v. Commissioner, T.C. Memo 2025-52 (Soroban II)	Applying the functional analysis to the same partners: they worked full time, were essential to the business, and their returns far exceeded any return on capital	Not limited partners “as such”; distributive shares subject to SE tax. The court looked at hours, role, how the partnership described them to investors, and the relationship between capital invested and income received.
Denham Capital Management LP v. Commissioner, T.C. Memo 2024-114	Private equity manager; same structure	Same result; the limited partners who ran the business were not passive investors.
Sirius Solutions LLLP (5th Cir., pending/decided 2025) (verify status and citation)	Appeal of the functional-analysis approach	Watch; the first appellate treatment.

The through-line: a partner who provides substantial services to the partnership’s business is not a limited partner for §1402(a)(13), and the share of profit attributable to those services is SE income. None of the cases involved a true passive investor losing; the exception still works for the person it was written for.

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Step 4: Applying It at the Desk

For each member of each multi-member LLC, every year, documented in the workpapers.

• Hours and role. More than 500 hours, or any management authority, or a role the business depends on: treat the full distributive share as SE income. This is the Castigliola/Soroban member.
• Pure investor. Contributed capital, no services, no management authority (manager-managed LLC with a different manager, or a documented passive role): the distributive share is excluded under §1402(a)(13). Guaranteed payments for capital are also excluded. Document the absence of services as you would document their presence.
• In between. A member who works part time, under 500 hours, without management authority, in a non-service business: the 1997 proposed regulations would treat her as a limited partner, and following them is a defensible position. State it in the file.
• Two classes of interest. Where the operating agreement creates a class held by passive investors and a separate class held by working members, with the same returns to the passive class as to unrelated passive investors, the proposed regulations’ bifurcation rule supports excluding the working member’s passive-class share. Rare in small LLCs, and the agreement has to actually do it.
• Rental and investment LLCs. Irrelevant: rental income and portfolio income are excluded from SE income for everyone under §1402(a)(1)–(3). The question only arises for an operating business.
• Box 14 code A on the K-1 should reflect the conclusion; the partner’s Schedule SE follows it. If the partnership’s preparer and the partner’s preparer disagree, the partner’s return controls the partner’s liability, and Form 8082 (notice of inconsistent treatment) is required.

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Step 5: Partner Compensation Mechanics

• No W-2. A partner is not an employee of the partnership (Rev. Rul. 69-184; Reg. §301.7701-2(c)(2)(iv)(C)(2), applied to disregarded entities in 2016). Compensation for services is a guaranteed payment, reported on the K-1 box 4, no withholding, estimated taxes by the partner. A W-2 to a partner is wrong and does not reduce SE income; it creates payroll-tax problems on top.
• Health insurance paid by the partnership for a partner: a guaranteed payment, included in the partner’s income, deducted by the partner under §162(l) above the line (Rev. Rul. 91-26). Subject to SE tax as a guaranteed payment.
• Retirement contributions for a partner (SEP, 401(k) employer share) are made by the partnership but deducted by the partner on the 1040 (§404(a)(8)); computed on net SE earnings after the SE-tax deduction and the contribution itself (the circular computation in Pub 560). Partners in an LLC that excludes a member’s share from SE income also cut that member off from retirement plan contributions based on it; no SE earnings, no plan compensation.
• Fringe benefits: partners are not employees for §105, §106, §125, §132 (except working condition and de minimis); cafeteria plan participation is barred.
• Spouses: a qualified joint venture election (§761(f)) lets a husband-wife unincorporated business file two Schedule Cs instead of a 1065; available only to spouses, not to an LLC in most states (Colorado is not a community-property state, so a spousal LLC must file a 1065 or elect S status) (verify the IRS’s position on state-law LLCs and §761(f)).

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Step 6: Structures People Try

• “Guaranteed payment equal to a salary, exclude the rest.” Castigliola. Fails for a member who manages or works substantially; the court saw no difference between this and the S corporation salary split, except that the law doesn’t allow it for partnerships.
• Manager-managed LLC with the working members as non-manager members. Removes management authority on paper; Soroban II looks past the paper to the function. Works only if the members actually don’t manage and don’t work substantially.
• An S corporation as the partner: each working member forms an S corporation that holds the LLC interest and employs the member. The LLC’s income flows to the S corporation; the S corporation pays the member reasonable compensation and distributes the rest. This is the structure that actually works, with the reasonable-compensation discipline from that page, and with the cost of a second entity and payroll. The IRS has not successfully attacked it where the S corporation is respected and the salary is reasonable.
• Converting the LLC to an S corporation for tax purposes (Form 2553): the simplest answer when the members’ interests are proportionate and no special allocations or §704(c) property exist. Our business-entities and S corporation pages cover when that makes sense; the §754 page covers why it doesn’t for appreciated real estate.

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A Worked Example

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Colorado

Colorado has no self-employment tax; its income tax applies to the member’s share through federal taxable income. Two interactions matter. The half-of-SE-tax deduction reduces federal AGI and therefore Colorado taxable income. And under the SALT Parity Act election, guaranteed payments are excluded from the electing entity’s Colorado taxable income (they are taxed to the partner on the partner’s own return), so a partnership that pays most of its profit as guaranteed payments gets little benefit from the PTE election; the distributive share is what the election covers. See the PTE election page.

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Questions at the desk

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Written for the Tax Shop desk; figures are for the 2026 tax year as currently published. Items marked (verify) are to be confirmed against primary sources before the figures freeze in December. Last updated October 16, 2026.