Another §1402(a)(13) SE Tax Case with Some Twists

• 06/03/2025

Last week, a taxpayer filed a petition with the Tax Court in Stelliam Investment Management LP v. Commissioner (Dkt. No. 7843-25; May 29, 2025), yet another investment manager case in which the IRS has denied the availability of the limited partner self-employment tax exclusion contained in §1402(a)(13). We’ve previously shared insights on recent developments in this space, including updates on Denham Capital and Soroban. This case is different than other reported cases because the investment manager is owned solely by a single family (as compared to multiple business associates) as well as the resultant approach taken by the IRS.

In the case, the “king” appears to have made gifts of limited partner interests to his spouse, a grantor trust for the benefit of his children, a trust for the benefit of nieces and nephews and a trust for the benefit of his siblings. The gifts to the trusts were reported on a gift tax return. Not only did the IRS assert that all the limited partners’ share of income should be recharacterized as SE income and allocated to the king, but the IRS also asserted that §704(e) (i.e., the “family partnership rules”) should be applied to reallocate to the king the taxable income allocated to the donees. Moreover, it appears that the IRS also asserted that the donees of the limited partner interests were not bona fide partners and that the partnership “was formed or availed of with a principal purpose to reduce substantially the present value of [the king’s] aggregate federal tax liability under the partnership anti-abuse rules of Treas. Reg. §1.701-2.”

By applying the little-used rules of §704(e)(1), apparently it is the IRS’s position that all the income of the limited partnership should have been allocated to the king, as it all related to the services he provided. It will be interesting to see if the IRS uses §704(e) in non-investment manager situations to reallocate FLP income away from donees of partnership interests.

This also appears to be the first reported time that the IRS used the anti-abuse regulation in the SE tax arena. In this regard, the taxpayer’s petition asserted that the partnership anti-abuse rules of Treas. Reg. §1.701-2 are invalid, citing Loper Bright (among other authority). It also will be interesting to monitor what the Tax Court says about this regulation, if Stelliam goes to trial and/or if another case asserting the invalidity of the regulation gets decided before Stelliam.

The status of the limited partner SE tax exclusion contained in §1402(a)(13) SE tax exclusion is one of today’s most controversial issues in the partnership arena, and it will be a hot topic discussed this year at our Tax Planning Forum® and Fundamentals of Flow-Through® programs. Registration remains open for our final spring Funamentals program, which will be held on June 17-19, and registration is open for all our fall and winter Forum and Fundamentals programs presented both virtually and in-person.