1702 Federal Register / Vol. 62, No. 8 / Monday, January 13, 1997 / Proposed Rules

26 CFR Part 1

[REG–209824–96]

RIN 1545–AU24

Definition of Limited Partner for SelfEmployment Tax Purposes

AGENCY: Internal Revenue Service (IRS),

Treasury.

ACTION: Notice of proposed rulemaking

and notice of public hearing.

SUMMARY: This document contains

proposed amendments to the

regulations relating to the selfemployment income tax imposed under

section 1402 of the Internal Revenue

Code of 1986. These regulations permit

individuals to determine whether they

are limited partners for purposes of

section 1402(a)(13), eliminating the

uncertainty in calculating an

individual’s net earnings from selfemployment under existing law. This

document also contains a notice of

public hearing on the proposed

regulations.

DATES: Written comments must be

received by April 14, 1997. Requests to

speak and outlines of oral comments to

be discussed at the public hearing

scheduled for May 21, 1997, at 10 a.m.

must be received by April 30, 1997.

ADDRESSES: Send submissions to:

CC:DOM:CORP:R (REG–209824–96),

room 5226, Internal Revenue Service,

POB 7604, Ben Franklin Station,

Washington, DC 20044. Submissions

may be hand delivered between the

hours of 8 a.m. and 5 p.m. to:

CC:DOM:CORP:R (REG–209824–96),

Courier’s Desk, Internal Revenue

Service, 1111 Constitution Avenue, NW,

Washington, DC. Alternatively,

taxpayers may submit comments

electronically via the Internet by

selecting the ‘‘Tax Regs’’ option on the

IRS Home Page, or by submitting

comments directly to the IRS Internet

site at http://www.irs.ustreas.gov/prod/

taxlregs/comments.html. The public

hearing will be held in the Auditorium,

Internal Revenue Service building, 1111

Constitution Avenue, NW, Washington,

DC.

FOR FURTHER INFORMATION CONTACT:

Concerning the regulation, Robert

Honigman, (202) 622–3050; concerning

submissions and the hearing, Christina

Vasquez, (202) 622–6808 (not toll-free

numbers).

SUPPLEMENTARY INFORMATION:

Background

This document contains proposed

amendments to the Income Tax

Regulations (26 CFR part 1) under

section 1402 of the Internal Revenue

Code and replaces the notice of

proposed rulemaking published in the

Federal Register on December 29, 1994,

at 59 FR 67253, that treated certain

members of a limited liability company

(LLC) as limited partners for selfemployment tax purposes. Written

comments responding to the proposed

regulations were received, and a public

hearing was held on June 23, 1995.

Under the 1994 proposed regulations,

an individual owning an interest in an

LLC was treated as a limited partner if

(1) the individual lacked the authority

to make management decisions

necessary to conduct the LLC’s business

(the management test), and (2) the LLC

could have been formed as a limited

partnership rather than an LLC in the

same jurisdiction, and the member

could have qualified as a limited partner

in the limited partnership under

applicable law (the limited partner

equivalence test). The intent of the 1994

proposed regulations was to treat

owners of an LLC interest in the same

manner as similarly situated partners in

a state law partnership.

Public comments on the 1994

proposed regulations were mixed. While

some commentators were pleased with

the proposed regulations for attempting

to conform the treatment of LLCs with

state law partnerships, others criticized

the 1994 proposed regulations based on

a variety of arguments.

A number of commentators discussed

administrative and compliance

problems with the 1994 proposed

regulations. For example, it was noted

that both the management test and the

limited partner equivalence test depend

upon legal or factual determinations

that may be difficult for taxpayers or the

IRS to make with certainty.

Another commentator pointed out

that basing the self-employment tax

treatment of LLC members on state law

limited partnership rules would lead to

disparate treatment between members of

different LLCs with identical rights

based solely on differences in the

limited partnership statutes of the states

in which the members form their LLC.

For example, State A’s limited

partnership act may allow a limited

partner to participate in a partnership’s

business while State B’s limited

partnership act may not. Thus, an LLC

member, who is not a manager, that

participates in the LLC’s business would

be a limited partner under the proposed

regulations if the LLC is formed in State

A, but not if the LLC is formed in State

B. Commentators asserted that this

disparate treatment is inherently unfair

for federal tax purposes.

Some commentators argued for a

‘‘material participation’’ test to

determine whether an LLC member’s

distributive share is included in the

individual’s net earnings from selfemployment. The proposed regulations

did not contain a participation test.

Commentators advocating a

participation test stressed that such a

test would eliminate uncertainty

concerning many LLC members’ limited

partner status and would better

implement the self-employment tax goal

of taxing compensation for services.

Other commentators argued for a

more uniform approach, stating that a

single test should govern all business

entities i.e., partnerships, LLCs, LLPs,

sole proprietorships, et al.) whose

members may be subject to selfemployment tax. These commentators

generally recognized, however, that a

change in the treatment of a sole

proprietorship or an entity that is not

characterized as a partnership for

federal tax purposes would be beyond

the scope of regulations to be issued

under section 1402(a)(13).

Finally, some commentators focused

on whether the Service would respect

the ownership of more than one class of

partnership interest for self-employment

tax purposes (bifurcation of interests).

The proposed regulations treated an

LLC member as a limited partner with

respect to his or her entire interest (if

the member was not a manager and

satisfied the limited partner equivalence

test), or not at all (if either the

management test or limited partner

equivalence test was not satisfied).

Commentators, however, pointed to the

legislative history of section 1402(a)(13)

to support their argument that Congress

only intended to tax a partner’s

distributive share attributable to a

general partner interest. Under this

argument, a partner that holds both a

general partner interest and a limited

partner interest is only subject to selfemployment tax on the distributive

share attributable to the partner’s

general partner interest. This intent also

may be inferred from the statutory

language of section 1402(a)(13) that the

self-employment tax does not apply to

‘‘* * * the distributive share of any

item of income or loss of a limited

partner, as such * * *.’’ Based on this

evidence, these commentators requested

that the proposed regulations be revised

to allow the bifurcation of interests for

self-employment tax purposes.

After considering the comments

received, the IRS and Treasury have

decided to withdraw the 1994 notice of

proposed rulemaking and to re-propose

amendments to the Income Tax
Federal Register / Vol. 62, No. 8 / Monday, January 13, 1997 / Proposed Rules 1703

Regulations (26 CFR part 1) under

section 1402 of the Code.

Explanation of Provisions

The proposed regulations contained

in this document define which partners

of a federal tax partnership are

considered limited partners for section

1402(a)(13) purposes. These proposed

regulations apply to all entities

classified as a partnership for federal tax

purposes, regardless of the state law

characterization of the entity. Thus, the

same standards apply when determining

the status of an individual owning an

interest in a state law limited

partnership or the status of an

individual owning an interest in an

LLC. In order to achieve this conformity,

the proposed regulations adopt an

approach which depends on the

relationship between the partner, the

partnership, and the partnership’s

business. State law characterizations of

an individual as a ‘‘limited partner’’ or

otherwise are not determinative.

Generally, an individual will be

treated as a limited partner under the

proposed regulations unless the

individual (1) has personal liability (as

defined in § 301.7701–3(b)(2)(ii) of the

Procedure and Administration

Regulations) for the debts of or claims

against the partnership by reason of

being a partner; (2) has authority to

contract on behalf of the partnership

under the statute or law pursuant to

which the partnership is organized; or,

(3) participates in the partnership’s

trade or business for more than 500

hours during the taxable year. If,

however, substantially all of the

activities of a partnership involve the

performance of services in the fields of

health, law, engineering, architecture,

accounting, actuarial science, or

consulting, any individual who

provides services as part of that trade or

business will not be considered a

limited partner.

By adopting these functional tests, the

proposed regulations ensure that

similarly situated individuals owning

interests in entities formed under

different statutes or in different

jurisdictions will be treated similarly.

The need for a functional approach

results not only from the proliferation of

new business entities such as LLCs, but

also from the evolution of state limited

partnership statutes. When Congress

enacted the limited partner exclusion

found in section 1402(a)(13), state laws

generally did not allow limited partners

to participate in the partnership’s trade

or business to the extent that state laws

allow limited partners to participate

today. Thus, even in the case of a state

law limited partnership, a functional

approach is necessary to ensure that the

self-employment tax consequences to

similarly situated taxpayers do not

differ depending upon where the

partnership organized.

The proposed regulations allow an

individual who is not a limited partner

for section 1402(a)(13) purposes to

nonetheless exclude from net earnings

from self-employment a portion of that

individual’s distributive share if the

individual holds more than one class of

interest in the partnership. Similarly,

the proposed regulations permit an

individual that participates in the trade

or business of the partnership to

bifurcate his or her distributive share by

disregarding guaranteed payments for

services. In each case, however, such

bifurcation of interests is permitted only

to the extent the individual’s

distributive share is identical to the

distributive share of partners who

qualify as limited partners under the

proposed regulation (without regard to

the bifurcation rules) and who own a

substantial interest in the partnership.

Together, these rules exclude from an

individual’s net earnings from selfemployment amounts that are

demonstrably returns on capital

invested in the partnership.

Proposed Effective Date

These regulations are proposed to be

effective beginning with the individual’s

first taxable year beginning on or after

the date these regulations are published

as final regulations in the Federal

Register.

Special Analyses

It has been determined that this notice

of proposed rulemaking is not a

significant regulatory action as defined

in EO 12866. Therefore, a regulatory

assessment is not required. It also has

been determined that section 553(b) of

the Administrative Procedure Act (5

U.S.C. chapter 5) does not apply to these

regulations, and, because the regulations

do not impose a collection of

information on small entities, the

Regulatory Flexibility Act (5 U.S.C.

chapter 6) does not apply. Pursuant to

section 7805(f) of the Internal Revenue

Code, this notice of proposed

rulemaking will be submitted to the

Chief Counsel for Advocacy of the Small

Business Administration for comment

on its impact on small business.

Comments and Public Hearing

Before these proposed regulations are

adopted as final regulations,

consideration will be given to any

written comments (a signed original and

eight (8) copies) that are submitted

timely to the IRS. All comments will be

available for public inspection and

copying.

A public hearing has been scheduled

for Wednesday, May 21, 1997, at 10 a.m.

in the Auditorium, Internal Revenue

Service building, 1111 Constitution

Avenue, NW, Washington, DC. Because

of access restrictions, visitors will not be

admitted beyond the Internal Revenue

Service building lobby more than 15

minutes before the hearing starts.

The rules of 26 CFR 601.601(a)(3)

apply to the hearing.

Persons that wish to present oral

comments at the hearing must submit

written comments by April 14, 1997 and

submit an outline of the topics to be

discussed and the time to be devoted to

each topic (signed original and eight (8)

copies) by April 30, 1997.

A period of 10 minutes will be

allotted to each person for making

comments.

An agenda showing the scheduling of

the speakers will be prepared after the

deadline for receiving outlines has

passed. Copies of the agenda will be

available free of charge at the hearing.

Drafting Information

The principal author of these

regulations is Robert Honigman of the

Office of Assistant Chief Counsel

(Passthroughs & Special Industries).

However, other personnel from the IRS

and Treasury Department participated

in their development.

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and

recordkeeping requirements.

Proposed Amendments to the

Regulations

Accordingly, 26 CFR part 1 is

proposed to be amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation

for part 1 continues to read in part as

follows:

Authority: 26 U.S.C. 7805 * * *

Par. 2. Section 1.1402(a)–2 is

amended by:

1. Revising the first sentence of

paragraph (d).

2. Removing the reference ‘‘section

702(a)(9)’’ in the first sentence of

paragraph (e) and adding ‘‘section

702(a)(8)’’ in its place.

3. Revising the last sentence of

paragraph (f).

4. Revising paragraphs (g) and (h).

5. Adding new paragraphs (i) and (j).

The revisions and additions read as

follows:
1704 Federal Register / Vol. 62, No. 8 / Monday, January 13, 1997 / Proposed Rules

§ 1.1402(a)–2 Computation of net earnings

from self-employment.

* * * * *

(d) * * * Except as otherwise

provided in section 1402(a) and

paragraph (g) of this section, an

individual’s net earnings from selfemployment include the individual’s

distributive share (whether or not

distributed) of income or loss described

in section 702(a)(8) from any trade or

business carried on by each partnership

of which the individual is a partner.

* * *

* * * * *

(f) * * * For rules governing the

classification of an organization as a

partnership or otherwise, see

§§ 301.7701–1, 301.7701–2, and

301.7701–3 of this chapter.

(g) Distributive share of limited

partner. An individual’s net earnings

from self-employment do not include

the individual’s distributive share of

income or loss as a limited partner

described in paragraph (h) of this

section. However, guaranteed payments

described in section 707(c) made to the

individual for services actually rendered

to or on behalf of the partnership

engaged in a trade or business are

included in the individual’s net

earnings from self-employment.

(h) Definition of limited partner—(1)

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.

(2) Limited partner. An individual is

treated as a limited partner under this

paragraph (h)(2) unless the individual—

(i) Has personal liability (as defined in

§ 301.7701–3(b)(2)(ii) of this chapter) for

the debts of or claims against the

partnership by reason of being a partner;

(ii) Has authority (under the law of

the jurisdiction in which the

partnership is formed) to contract on

behalf of the partnership; or

(iii) Participates in the partnership’s

trade or business for more than 500

hours during the partnership’s taxable

year.

(3) 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—

(i) 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,

(ii) 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.

(4) 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—

(i) 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

(ii) 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.

(5) 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.

(6) Additional definitions. Solely for

purposes of this paragraph (h)—

(i) 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.

(ii) 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.

(iii) 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.

(iv) 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

1,000 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 selfemployment 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 1705participated in LLC’s business for more
Federal Register / Vol. 62, No. 8 / Monday, January 13, 1997 / Proposed Rules 1705

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.

Margaret Milner Richardson,

Commissioner of Internal Revenue.

[FR Doc. 97–701 Filed 1–10–97; 8:45 am]

BILLING CODE 4830–01–U

DEPARTMENT OF THE INTERIOR

Bureau of Land Management

43 CFR Part 3100

[WO–310–3110–02 1A]

Royalty Rate Reduction for Stripper Oil

Properties

AGENCY: Bureau of Land Management,

Interior.

ACTION: Review of regulations;

reopening of comment period.

SUMMARY: On November 4, 1996, the

Bureau of Land Management (BLM)

published a document in the Federal

Register announcing a review of the

royalty rate reducing reduction available

to producers of Federal stripper well

properties (61 FR 56651). The document

requested comments from the public on

the effectiveness of this program during

a 60-day period that ended on January

3, 1997. BLM has received numerous

requests from the public for additional

time to research this issue and is

reopening the comment period for an

additional 60 days.

DATES: Comments must be submitted on

or before March 14, 1997.

ADDRESSES: If you wish to comment you

may: (a) Hand-deliver comments to the

Bureau of Land Management,

Administrative Record, Room 401, 1620

L St., NW., Washington, DC; (b) Mail

comments to the Bureau of Land

Management, Administrative Record,

Room 401LS, 1849 C Street, NW,

Washington, DC 20240; or (c) Transmit

comments electronically via the Internet

to WOComment@wo.blm.gov. Please

include Attn: ‘‘Stripper Wells’’ and your

name and address in your message. If

you do not receive a confirmation from

the system that we have received your

Internet message, contact us directly at

(202) 452–5030.

You will be able to review comments

at BLM’s Regulatory Affairs office,

Room 401, 1620 L St., NW.,

Washington, D.C., during regular

business hours (7:45 a.m. to 4:15 p.m.)

Monday through Friday.

FOR FURTHER INFORMATION CONTACT:

Wayne Melton, Roswell (NM) District

Office, (505) 627–0254.

Dated: January 8, 1997.

Frank Bruno,

Regulatory Affairs Group.

[FR Doc. 97–738 Filed 1–10–97; 8:45 am]

BILLING CODE 4310–84–P

DEPARTMENT OF COMMERCE

National Oceanic and Atmospheric

Administration

50 CFR Parts 630 and 678

[I.D. 010297A]

Atlantic Swordfish Fishery; Atlantic

Shark Fishery; Public Hearings on

Draft Amendment 1 to the Fishery

Management Plan for Sharks of the

Atlantic Ocean

AGENCY: National Marine Fisheries

Service (NMFS), National Oceanic and

Atmospheric Administration (NOAA),

Commerce.

ACTION: Public hearings; request for

comments.

SUMMARY: The Highly Migratory Species

Management Division (HMS Division)

will convene 11 public hearings on

Draft Amendment 1 to the Fishery

Management Plan for Sharks of the

Atlantic Ocean (Shark FMP) and a

proposed limited access system for the

Atlantic swordfish fishery. Draft

Amendment 1 will address a limited

access system for the Atlantic shark

fishery. Draft Amendment 1 to Fishery

Management Plan for Atlantic

Swordfish (Swordfish FMP), which will

address a limited access system for that

fishery, will be published in early

January.

DATES: Written comments on Draft

Amendment 1 to the Shark FMP will be

accepted until February 28, 1997. Public

hearings will be held in January and

February. See SUPPLEMENTARY

INFORMATION for specific dates and times

of the hearings.

ADDRESSES: Written comments should

be sent to William T. Hogarth, Acting

Chief, HMS Division, Office of

Sustainable Fisheries F/SF1, 1315 EastWest Highway, Silver Spring, MD 20910

(FAX: 301–713–1917). Clearly mark the

outside of the envelope ‘‘Limited Access

Comments.’’ Copies of the proposed rule

and draft amendment 1 to the Shark

FMP, which includes an environmental

assessment and regulatory impact

review, are available from Margo

Schulze at the same address. Public

hearings will be held in Maine,

Massachusetts, Rhode Island, New York,

New Jersey, North Carolina, Florida, and

Louisiana. See SUPPLEMENTARY

INFORMATION for locations of the

hearings.

FOR FURTHER INFORMATION CONTACT:

Margo Schulze, Fishery Biologist, or

James Chambers, Fishery Management

Specialist, HMS Division, 301–713–

2347.

SUPPLEMENTARY INFORMATION: Issues that

will be addressed in Draft Amendment

1 to the Shark FMP include: Proposed

implementation of a two-tiered permit

system consisting of directed and

incidental permits for the commercial

fishery, eligibility criteria for these

permits based on historical

participation, transferability provisions,

the permitting process, upgrading

restrictions, ownerships limits, and an

incidental permit catch limit. Draft

Amendment 1 to the Swordfish FMP

will be published in early January and

will address similar issues to those in

Draft Amendment 1 to the Shark FMP.

A complete description of the

measures, including the purpose and

need for the proposed action, is

contained in the proposed rule

published December 27, 1996 (61 FR

68202), and is not repeated here. Copies

of the proposed rule and Draft