(h) DEFINITION OF LIMITED PARTNER--
- IN GENERAL. Solely for purposes of section 1402(a)(13) and
paragraph (g) of this section, an individual is considered to be a
limited partner to the extent provided in paragraphs (h)(2), (h)(3),
(h)(4), and (h)(5) of this section.
- LIMITED PARTNER. An individual is treated as a limited partner
under this paragraph (h)(2) unless the individual--
- Has personal liability (as defined in section 301.7701-
3(b)(2)(ii) of this chapter for the debts of or claims against
the partnership by reason of being a partner;
- Has authority (under the law of the jurisdiction in
which the partnership is formed) to contract on behalf of the
partnership; or
- Participates in the partnership's trade or business
for more than 500 hours during the partnership's taxable year.
- EXCEPTION FOR HOLDERS OF MORE THAN ONE CLASS OF INTEREST. An
individual holding more than one class of interest in the partnership
who is not treated as a limited partner under paragraph (h)(2) of this
section is treated as a limited partner under this paragraph (h)(3)
with respect to a specific class of partnership interest held by such
individual if, immediately after the individual acquires that class of
interest--
- Limited partners within the meaning of paragraph (h)(2)
of this section own a substantial, continuing interest in that
specific class of partnership interest; and,
- The individual's rights and obligations with respect to
that specific class of interest are identical to the rights and
obligations of that specific class of partnership interest held
by the limited partners described in paragraph (h)(3)(i) of this
section.
- EXCEPTION FOR HOLDERS OF ONLY ONE CLASS OF INTEREST. An individual
who is not treated as a limited partner under paragraph (h)(2) of this
section solely because that individual participates in the
partnership's trade or business for more than 500 hours during the
partnership's taxable year is treated as a limited partner under this
paragraph (h)(4) with respect to the individual's partnership interest
if, immediately after the individual acquires that interest--
- Limited partners within the meaning of paragraph (h)(2)
of this section own a substantial, continuing interest in that
specific class of partnership interest; and
- The individual's rights and obligations with respect to
the specific class of interest are identical to the rights and
obligations of the specific class of partnership interest held by
the limited partners described in paragraph (h)(4)(i) of this
section.
- EXCEPTION FOR SERVICE PARTNERS IN SERVICE PARTNERSHIPS. An
individual who is a service partner in a service partnership may not
be a limited partner under paragraphs (h)(2), (h)(3), or (h)(4) of
this section.
- ADDITIONAL DEFINITIONS. Solely for purposes of this paragraph (h)-
-
- A CLASS OF INTEREST is an interest that grants the
holder specific rights and obligations. If a holder's rights and
obligations from an interest are different from another holder's
rights and obligations, each holder's interest belongs to a
separate class of interest. An individual may hold more than one
class of interest in the same partnership provided that each
class grants the individual different rights or obligations. The
existence of a guaranteed payment described in section 707(c)
made to an individual for services rendered to or on behalf of a
partnership, however, is not a factor in determining the rights
and obligations of a class of interest.
- A SERVICE PARTNER is a partner who provides services to
or on behalf of the service partnership's trade or business. A
partner is not considered to be a service partner if that partner
only provides a de minimis amount of services to or on behalf of
the partnership.
- A SERVICE PARTNERSHIP is a partnership substantially
all the activities of which involve the performance of services
in the fields of health, law, engineering, architecture,
accounting, actuarial science, or consulting.
- A SUBSTANTIAL INTEREST IN A CLASS OF INTEREST is
determined based on all of the relevant facts and circumstances.
In all cases, however, ownership of 20 percent or more of a
specific class of interest is considered substantial.
(i) EXAMPLE. The following example illustrates the principles of paragraphs
(g) and (h) of this section:
EXAMPLE.
(i) A, B, and C form LLC, a limited liability company, under the laws
of State to engage in a business that is not a service partnership
described in paragraph (h)(6)(iii) of this section. LLC, classified as
a partnership for federal tax purposes, allocates all items of income,
deduction, and credit of LLC to A, B, and C in proportion to their
ownership of LLC. A and C each contribute $1x for one LLC unit. B
contributes $2x for two LLC units. Each LLC unit entitles its holder
to receive 25 percent of LLC's tax items, including profits. A does
not perform services for LLC; however, each year B receives a
guaranteed payment of $6x for 600 hours of services rendered to LLC
and C receives a guaranteed payment of $10x for 1000 hours of services
rendered to LLC. C also is elected LLC's manager. Under State's law, C
has the authority to contract on behalf of LLC.
(ii) APPLICATION OF GENERAL RULE OF PARAGRAPH (h)(2) OF THIS SECTION.
A is treated as a limited partner in LLC under paragraph (h)(2) of
this section because A is not liable personally for debts of or claims
against LLC, A does not have authority to contract for LLC under
State's law, and A does not participate in LLC's trade or business for
more than 500 hours during the taxable year. Therefore, A's
distributive share attributable to A's LLC unit is excluded from A's
net earnings from self-employment under section 1402(a)(13).
(iii) DISTRIBUTIVE SHARE NOT INCLUDED IN NET EARNINGS FROM SELF-
EMPLOYMENT UNDER PARAGRAPH (h)(4) OF THIS SECTION. B's guaranteed
payment of $6x is included in B's net earnings from self-employment
under section 1402(a)(13). B is not treated as a limited partner under
paragraph (h)(2) of this section because, although B is not liable for
debts of or claims against LLC and B does not have authority to
contract for LLC under State's law, B does participates in LLC's trade
or business for more than 500 hours during the taxable year. Further,
B is not treated as a limited partner under paragraph (h)(3) of this
section because B does not hold more than one class of interest in
LLC. However, B is treated as a limited partner under paragraph (h)(4)
of this section because B is not treated as a limited partner under
paragraph (h)(2) of this section solely because B participated in
LLC's business for more than 500 hours and because A is a limited
partner under paragraph (h)(2) of this section who owns a substantial
interest with rights and obligations that are identical to B's rights
and obligations. In this example, B's distributive share is deemed to
be a return on B's investment in LLC and not remuneration for B's
service to LLC. Thus, B's distributive share attributable to B's two
LLC units is not net earnings from self-employment under section
1402(a)(13).
(iv) DISTRIBUTIVE SHARE INCLUDED IN NET EARNINGS FROM SELF-EMPLOYMENT.
C'S guaranteed payment of $10x is included in C's net earnings from
self-employment under section 1402(a). In addition, C's distributive
share attributable to C's LLC unit also is net earnings from self-
employment under section 1402(a) because C is not a limited partner
under paragraphs (h)(2), (h)(3), or (h)(4) of this section. C is not
treated as a limited partner under paragraph (h)(2) of this section
because C has the authority under State's law to enter into a binding
contract on behalf of LLC and because C participates in LLC's trade or
business for more than 500 hours during the taxable year. Further, C
is not treated as a limited partner under paragraph (h)(3) of this
section because C does not hold more than one class of interest in
LLC. Finally, C is not treated as a limited partner under paragraph
(h)(4) of this section because C has the power to bind LLC. Thus, C's
guaranteed payment and distributive share both are included in C's net
earnings from self-employment under section 1402(a).
(j) EFFECTIVE DATE. Paragraphs (d), (e), (f), (g), (h), and (i) are
applicable beginning with the individual's first taxable year
beginning on or after the date this section is published as a final
regulation in the Federal Register.
[62 FR 1702, January 13, 1997]
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