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Editorial 7 MIN READ

The limited partnership, a decade in

Still the default for real-estate syndications and private funds, now with an SE-tax question the Tax Court has started answering

The Editors
Staff, Incorporator.org
7 min read Updated
Contents 6 sections
  1. Formation mechanics under Delaware RULPA
  2. Tax treatment: Subchapter K by default
  3. The Soroban problem
  4. The CTA overhang
  5. Where the LP still wins
  6. Sources

he limited partnership is the form sophisticated capital still picks when it has a choice. Ten years into the LLC's near-total victory in small-business formation, the LP remains the default for real-estate syndications, private-equity funds, and venture funds, and the reason is structural rather than sentimental.

A limited partnership has two kinds of partners. The general partner runs the business and carries unlimited liability for its debts. The limited partners put in capital, stay out of management, and risk only what they contributed. That split, codified in Delaware at 6 Del. C. § 17-303, is exactly the economic shape a fund sponsor wants: one fiduciary with authority, many passive investors whose downside is capped at their commitment.

Formation mechanics under Delaware RULPA

Delaware's Revised Uniform Limited Partnership Act sits at 6 Del. C. Chapter 17. Formation is a certificate of limited partnership filed with the Division of Corporations under § 17-201, naming the LP, its registered office and agent, and the name and mailing address of each general partner. Limited partners are not named on the public certificate; they appear only in the partnership agreement, which Delaware does not require you to file.

§ 17-303 is the provision the fund bar cares about most. A limited partner "is not liable for the obligations of a limited partnership by reason of being a limited partner" unless the limited partner also "participates in the control of the business." The statute then lists a long menu of safe-harbor activities: consulting, voting on amendments, serving on an advisory committee, approving transactions. In 2025 the practical answer is that a well-drafted LP agreement with a committed LLC general partner gives limited partners a liability shield the courts respect.

The general partner's unlimited exposure is why almost no sponsor serves as GP in its natural person. The standard structure puts an LLC in the GP seat, so the LP's liability stops at the GP entity and the GP entity's liability stops at the principals behind it. Practitioners call this the double wrap. Fund docs will often add a separate management company LLC above the GP to isolate fee streams from carry.

Tax treatment: Subchapter K by default

A multi-member LP is a partnership for federal tax purposes. That routes it into Subchapter K, which is the most flexible allocation regime in the Code. Partners can specify how items of income, gain, loss, deduction, and credit are divided, so long as the allocations have "substantial economic effect" under IRC § 704(b). The regulations at Treas. Reg. § 1.704-1(b)(2) spell out the mechanical tests: capital accounts maintained on a tax basis, liquidation in accordance with positive capital account balances, and a deficit-restoration obligation or qualified income offset. Real-estate sponsors rely on § 704(b) to push depreciation to the investor class that can use it and to track the preferred-return waterfalls that every operating agreement now contains. Fund sponsors rely on § 704(b) to make carried interest work at all.

The LP also remains the cleanest vehicle for the nonrecourse-debt basis allocations under Treas. Reg. § 1.752-3 that let real-estate investors take losses against their share of the mortgage, and for the IRC § 1061 three-year holding rule on carried interest.

The Soroban problem

The cleanest change in LP tax law since 2015 has come from the Tax Court, on a statute Congress wrote in 1977 and has not touched since.

IRC § 1402(a)(13) carves out from self-employment tax "the distributive share of any item of income or loss of a limited partner, as such, other than guaranteed payments." For decades the fund industry read "limited partner" the way state law reads it: if your LP agreement calls you a limited partner, your share of fund income is not subject to SE tax.

The IRS never accepted that reading, and in November 2023 the Tax Court held in Soroban Capital Partners LP v. Commissioner, 161 T.C. No. 12 (Nov. 28, 2023), that the carveout requires a functional analysis, not a formal title. A partner who holds the "limited partner" label but actively renders services to the partnership is not a "limited partner, as such" within the meaning of § 1402(a)(13). The court declined to decide at summary judgment whether Soroban's specific principals met the functional test and set the case for trial. In May 2024, the follow-up opinion at Soroban Capital Partners LP v. Commissioner, 163 T.C. No. 1 (May 28, 2024), resolved a procedural posture on partnership-level versus partner-level determinations under TEFRA, clearing the way for the functional inquiry to proceed.

The shape of the functional test comes from Renkemeyer, Campbell & Weaver, LLP v. Commissioner, 136 T.C. 137 (2011), where the Tax Court held that an LLP's service-partner attorneys could not claim the § 1402(a)(13) exclusion because they were the business. The factors the court has looked at include capital contributed, time devoted to the partnership, whether the distributive share resembles a return on services or a return on capital, and the partner's role in management.

Denham Capital Management LP v. Commissioner, docketed in the Tax Court, is the next shoe. It tees up the same § 1402(a)(13) question for another private-equity sponsor and has been fully briefed; a decision is pending as of this writing. If Denham comes out the same way, the practical effect is that fund general partners will owe SE tax on the share of fund management income attributable to services, which is most of it in the first few years of a fund's life and tapers as capital appreciates. Fund CFOs have already started modeling the exposure back four open tax years.

The planning response, for existing funds, is to document capital accounts and hours in a way that supports a capital-return characterization for at least part of the distributive share. For new funds, practitioners are revisiting the LLLP and the state-law limited-partner-manager split, though neither forecloses the functional test.

The CTA overhang

Every LP formed or registered in the United States is a "reporting company" under the Corporate Transparency Act, 31 U.S.C. § 5336, unless one of the exceptions applies. The statute requires the LP to file a beneficial-ownership report with FinCEN naming every individual who owns 25 percent or more of the entity or exercises substantial control, along with identifying information and an image of a government ID.

Enforcement has been whiplash. After a series of injunctions in the Northern District of Texas and the Fifth Circuit, the Supreme Court stayed the injunction in McHenry v. Texas Top Cop Shop, Inc. on January 23, 2025, leaving the reporting requirement in force while litigation continues. FinCEN's compliance deadlines were then pushed back by interim rulemaking, and as of this writing the operative deadline for most pre-2024 entities is March 21, 2025, with post- formation 30-day clocks for new entities. The one reliable statement is that the rule is in force now; the next one may not be.

For the LP, the CTA is friction rather than threat. Fund sponsors already collect the diligence file. What changes is the obligation to refile within 30 days of any change to the reported information: a new GP principal, a new 25-percent LP, a replacement of a listed control person. The penalty exposure is enough to get fund administrators to automate the tracking.

Where the LP still wins

A decade of LLC dominance has not dislodged the LP from the places where capital stacks get complex. The preferred-return waterfall, the clawback, the carried-interest promote, and the side-letter architecture of a private fund all map cleanly onto the GP-LP structure and the § 704(b) allocation regime. Institutional LPs already have the subscription documents, the W-9s, and the tax packages set up for K-1s. The LLC can reach the same economic result through a manager-managed structure with the same waterfall math, and for small real-estate deals it does. At fund scale, the LP remains the default because the investor side of the table expects it.

The two open questions in 2025 are the SE-tax question the Tax Court is finishing, and whether the CTA survives the term. A reader who wants the Delaware formation mechanics for the related LLC product can read our Delaware April 2016 guide. The LP sits one form over at the same Division, with a different certificate and a tax regime about to have its first real contested redefinition since Carter.

Sources

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