Internal Revenue Service
Revenue Ruling

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 Rev. Rul. 72-73

1972-1 C.B. 273

Sec. 702
Sec. 1402

IRS Headnote

Individuals not members of a partnership, who made contributions to a limited partner to provide partnership capital, do not derive self-employment income as a result of receiving a pro rata portion of the limited partner's share of profits.

Full Text

Rev. Rul. 72-73

Advice has been requested whether income received by individuals under the circumstances described below is to be included in their net earnings from self-employment for purposes of the Self-Employment Contributions Act of 1954 (chapter 2, subtitle A, Internal Revenue Code of 1954).

L is a limited partner in P partnership which is engaged in the conduct of a trade or business. In order to acquire funds for his investment in P, L enters into separate agreements with individuals A, B, and C, each of whom pays to L a sum of money to be used for a contribution to the capital of P under L's name. The agreements provide that L will pay over to A, B, and C that portion of his share of the profits of P attributable to each individual's contribution, as well as the principal of each individual's contribution upon dissolution of P, as and when such profits or principal are received by L, and L will retain the portion attributable to his own investment in P. L has no authority, discretion, or power to invest the sum of money in any other business enterprise or to make any other use thereof.

A, B, and C render no services for P and are not employees thereof. P is not accountable to them and they have no legal or direct claim or interest in P, under local law. Nor do they have any right under their arrangement with L to participate in the control or management of L's investment in P. Their rights are confined to whatever rights they can demonstrate to a pro rata portion of L's share of the profits of P (or its assets upon its dissolution). A, B, and C have no similar arrangements with other partners of P, nor with partners of any other partnerships.

Specifically, the question presented is whether the income of A, B, and C attributable to their contributions to L are "net earnings from self-employment" within the meaning of section 1402(a) of the Act.

Section 1402(a) of the Act defines the term "net earnings from self-employment" to include the gross income derived by an individual from any "trade or business" carried on by such individual either individually or as a member of a partnership, less the deductions allowed by Chapter 1 of the Internal Revenue Code of 1954 that are attributable to such trade or business. Thus, for purposes of determining net earnings from self-employment, it is relevant whether a particular individual is engaged in the conduct of a trade or business himself and whether he is a member of a partnership engaged in the conduct of a trade or business.

In the instant case the P partnership (of which L is a limited partner) is a valid partnership for income tax purposes. However, even though L is a member of P for self-employment tax purposes, there is no basis for concluding that A, B, and C are members of P merely because they have arrangements to receive a share of the profits L receives from P, since A, B, and C have no legal basis under local law to claim to be partners in P. Furthermore, under the stated facts, there is no basis for concluding that A, B, and C are engaged in the conduct of a trade or business, either individually or by virtue of their relationship with L. It is P which carries on the trade or business.

A, B, and C do not have net earnings from self-employment under the arrangements, either as individuals or as members of a partnership carrying on a trade or business, because (1) they are not engaged in the conduct of a trade or business, either individually or under the separate arrangements with L, and (2) their right to such income is attributable solely to their arrangements with L.

Accordingly, in the instant case, the income received by A, B, and C is not to be included in their net earnings from self-employment for purposes of the Self-Employment Contributions Act.