If you own a piece of a multi-member LLC or a partnership, there’s a line in the tax code you’re either relying on or ignoring — and a lot of owners don’t know which.
Section 1402(a)(13) says a limited partner’s distributive share of partnership income isn’t subject to self-employment tax. Guaranteed payments for services still are. But the profit share itself? Excluded.
On a $200,000 share of profits, that exclusion is worth about $28,200 a year.
Run the number
Self-employment tax in 2026 is 15.3% — 12.4% for Social Security on the first $184,500 of net earnings, plus 2.9% for Medicare with no ceiling. Net earnings are 92.35% of your share.
Take a $200,000 distributive share:
- Net earnings from self-employment: $200,000 × 92.35% = $184,700
- Social Security: 12.4% × $184,500 = $22,878
- Medicare: 2.9% × $184,700 = $5,356
- Total: about $28,234
Half of that is deductible above the line, so the real cost lands closer to $21,000 depending on your bracket. Still a large number to be wrong about — and it repeats every year.
The fight the IRS has been losing and winning at the same time
For years the IRS has argued that “limited partner” in that statute doesn’t mean whatever your state paperwork says. Their position is a functional test: if you work in the business — bring in clients, manage people, make decisions — you’re a partner performing services, and your share is self-employment income no matter what the certificate filed with the state calls you.
The Tax Court agreed with that reading in a series of decisions, and it stuck. Partners who thought they had a clean exclusion found out they didn’t.
Then in January 2026, a federal appeals court went the other way. It held that “limited partner” means exactly what it means under state partnership law — if you hold limited partner status and the liability shield that comes with it, you’re covered, and how hard you work is beside the point.
So there are now two competing answers in the federal system, and the appeal that matters most for New York owners is still pending. The Second Circuit — which covers New York, Connecticut, and Vermont — has one of these cases in front of it and hasn’t ruled.
What that means for you here, right now: you don’t have a settled answer. Anyone telling you this is resolved is telling you about a different circuit.
The part most owners get wrong
Here’s what gets missed in all of this. Every one of those cases involved a state-law limited partnership. That’s a specific entity — an LP or LLLP, with a general partner and limited partners, formed under a state’s limited partnership statute.
Most of my clients don’t have one. They have an LLC.
An LLC member is not a limited partner. There is no such thing as a “limited partner” in an LLC — there are members, and maybe managers. The statutory exception was written in 1977, before LLCs existed in most states. The IRS proposed regulations in 1997 to sort out how it applies to LLC members. Those regulations were never finalized. They’ve sat in proposed form for nearly thirty years.
So if you’re an LLC member relying on the limited partner exception, you’re relying on an exception that doesn’t clearly reach your entity, interpreted under a test two courts now disagree about, in a circuit that hasn’t spoken.
That’s not a plan. That’s a position.
What I actually tell clients
If your income runs through a multi-member LLC and you work in the business, assume your full distributive share is subject to self-employment tax until someone shows you a solid reason otherwise. Plan and pay estimates on that basis. If the law moves in your favor later, you can amend. If you plan the other way and the law doesn’t move, you’ve got three years of underpayments plus interest and penalties — and the estimated tax penalty math is not kind.
If you’re genuinely passive — you put money in, you don’t work there, you don’t manage anyone — your position is much stronger under either test. Document it. Board of a company you don’t operate is different from running the place.
If the self-employment tax is the problem, the S-Corp is usually the answer, not a partnership label. An S-Corp splits your income into wages (payroll taxes apply) and distributions (they don’t). That structure has decades of settled law behind it, an actual standard to meet, and none of this uncertainty. The tradeoff is you have to pay yourself a defensible salary — see S-Corp reasonable salary — and there are real cases where it costs you more than it saves, covered in when an S-Corp costs you money.
Run your own numbers on the LLC vs. S-Corp calculator before you decide anything. And if you want the plain-English version of the structural differences first, start with S-Corp vs. LLC vs. sole proprietorship.
Three questions to answer before year-end
- What entity do I actually have? Pull the filed formation document. Not what your attorney called it in an email — what the state has on file. LP and LLC are different worlds here.
- Is my K-1 splitting income between guaranteed payments and distributive share, and does that split match what I actually do? Guaranteed payments for services are self-employment income under every version of this. There’s no argument.
- If the answer went against me, what’s the exposure? Multiply your distributive share by roughly 15.3% and then by the number of open years. That’s the number to make a decision against.
I’d rather have this conversation in August than in March, when the return is due and the options have narrowed to one.
This post is for general informational purposes only and does not constitute tax, legal, or financial advice. The application of Section 1402(a)(13) is unsettled and depends on entity type, state law, your role in the business, and the circuit you're in. Rates and thresholds cited are for 2026 and change annually. Consult a qualified tax professional about your own facts before taking any position on a filed return. Geiger Tax & Accounting, Amityville, NY · (631) 532-5622 · info@geigertax.com.