Are Limited Partners Subject to Self-Employment Tax?

Self-employment (SE) tax funds Social Security and Medicare benefits for individuals who work for themselves. This tax applies to net earnings from self-employment, ensuring self-employed individuals contribute to these federal programs. A limited partner in a partnership often acts as a passive investor, contributing capital without engaging in daily management or incurring personal liability for partnership debts beyond their investment. The Internal Revenue Service (IRS) rules dictate when a limited partner’s income is subject to SE tax.

Understanding a Limited Partner for Tax Purposes

The Internal Revenue Service (IRS) defines a “limited partner” for self-employment tax purposes differently from how state laws might define one. Under Internal Revenue Code Section 1402, a partner is typically considered a limited partner for self-employment tax if they meet specific criteria related to their involvement in the partnership’s business. This tax-specific definition focuses on the nature of the partner’s activities and their liability.

To qualify as a limited partner for self-employment tax purposes, an individual generally must lack personal liability for the partnership’s debts beyond their capital contribution. They must also not participate in the management or day-to-day operations of the partnership’s trade or business. Furthermore, a limited partner typically does not provide services to the partnership in their capacity as a partner. These three conditions help distinguish a passive investor from an active participant in the business.

This distinction is important because it determines whether a partner’s share of partnership income is viewed as an investment return or as earnings from self-employment. Income from active participation in a trade or business is generally subject to self-employment tax. In contrast, income that is truly passive, reflecting an investment rather than active labor, is typically excluded from self-employment tax calculations. The IRS scrutinizes the actual activities and responsibilities of a partner, regardless of their formal designation under state law.

The General Rule for Limited Partner Self-Employment Tax

The general rule regarding self-employment tax for limited partners states that their distributive share of partnership income is not subject to this tax. This exclusion applies specifically to the income they receive as a passive investor in the partnership. The rationale behind this exclusion is that the income is considered more akin to an investment return rather than earnings derived from active involvement in a trade or business.

This means that a limited partner’s share of the partnership’s ordinary business income, reported on Schedule K-1 (Form 1065), does not flow through to Schedule SE (Form 1040) for self-employment tax calculation. This exclusion prevents passive investment income from being treated as earned income for Social Security and Medicare tax purposes. This general principle helps differentiate between active business earnings and passive returns on capital.

If a limited partner maintains a passive role, without providing services or participating in management, their portion of the partnership’s operating profits will avoid self-employment tax. This significantly impacts their overall tax burden, as self-employment tax can add a substantial amount to an individual’s tax liability. It underscores the importance of understanding the specific nature of a partner’s involvement.

Specific Scenarios Requiring Self-Employment Tax

Even with the general rule, certain situations require a limited partner to pay self-employment tax on their partnership earnings. One common scenario involves guaranteed payments for services rendered to the partnership. If a limited partner receives such payments for management, consulting, or other services provided to the partnership, these amounts are subject to self-employment tax. These payments are considered earnings from services, distinct from a distributive share of profits, and are reported separately on Schedule K-1.

A partner formally designated as “limited” under state law may still be considered an active participant for self-employment tax purposes if they provide significant services or engage in management. The IRS may reclassify such a partner as a general partner for self-employment tax purposes, even if their legal status remains limited. Active participation can be indicated by:

• Having authority to contract on behalf of the partnership.
• Regularly working more than a few hundred hours annually in the business.
• Being personally liable for partnership debts.

This reclassification means their distributive share of income could become subject to self-employment tax.

Limited Liability Company (LLC) members often face confusion regarding self-employment tax because LLCs can be taxed as partnerships. For self-employment tax purposes, an LLC member is treated as either a general partner or a limited partner based on their actual involvement, management authority, and personal liability. Factors the IRS considers include:

• Whether the member is personally liable for the LLC’s debts.
• Having authority to act on behalf of the LLC.
• Performing more than a minimal amount of services for the business.

A member who actively participates in the LLC’s trade or business, similar to a general partner, will have their distributive share of income subject to self-employment tax.

Calculating and Reporting Self-Employment Income

If a limited partner’s income is determined to be subject to self-employment tax, specific steps are required for calculation and reporting. Self-employment tax is calculated on net earnings from self-employment, which typically includes the partner’s share of ordinary business income and any guaranteed payments for services.

The tax is computed using specific Social Security and Medicare tax rates, which for 2025 remain at 12.4% for Social Security (up to an annual earnings limit) and 2.9% for Medicare, for a combined rate of 15.3%.

The calculation begins with 92.35% of the net earnings from self-employment. This percentage accounts for a deduction allowed for one-half of the self-employment taxes paid, which is treated as a business expense. For example, if net earnings subject to self-employment tax are $100,000, the amount subject to the 15.3% rate would be $92,350. This calculated amount is then reported on the individual’s income tax return.

The partnership provides the necessary information on Schedule K-1 (Form 1065) to each partner. This form reports the partner’s distributive share of income, as well as any guaranteed payments made to them. The partner uses the relevant information from their Schedule K-1 to complete Schedule SE (Form 1040), Self-Employment Tax. The amount from Schedule SE is then carried over to the main Form 1040.