By RALPH LEVY
Dickinson Wright
In a prior article in this publication, I provided guidance for physicians and other medical professionals on how to compare the taxes payable under competing offers to join practice groups. I pointed out that these taxes will vary depending on several factors, including whether the offer includes equity ownership and whether the group is organized as a professional corporation (PC) or a professional limited liability company (PLLC). Although it appears that a recent decision by the 5th Circuit Court of Appeals on the self-employment taxes payable by a limited liability limited partnership could affect this guidance, on a closer look at this decision, it does not provide any tax relief to physicians and other medical professionals whose practice group is organized as a PLLC.
If the offer includes ownership in the practice entity that was organized as a PLLC and base compensation and contingent compensation based on the individual efforts of the physician or other medical provider (such as a percentage of billings collected by the PLLC from services provided by the physician or other provider), the cash compensation paid by the PLLC for services is treated as “guaranteed compensation” that is subject to Social Security taxes of 12.4% of the then applicable contribution and benefit base ($184,500 for 2026), to Medicare taxes of 2.9% and to the additional Medicare tax of 0.9% of annual cash compensation paid in excess of $200,000 ($250,000 if the employed professional files a joint return).
By contrast, if any portion of the compensation payable to the physician or other medical provider is based on performance of the PLLC (rather than the individual performance of the provider), the IRS contends that this portion of the provider’s income is similarly taxed even though it is earned based on the practice group’s performance and is not guaranteed to the provider. A recent Fifth Circuit Court of Appeals decision, Sirius Solutions, LLLP v. Comm’r, could have an impact on the tax treatment of this portion of compensation paid by the PLLC to its providers. This case dealt with the application of the “limited partnership exception” (LP Exception) to self-employment (SE) income to the five limited partners of a Delaware limited liability limited partnership (LLLP) that provided business consulting services through over 200 employees but was owned by one general partner and five limited partners. Even though the limited partners were heavily involved in the LLLP’s client services, Sirius reported all of the distributive shares of income to its limited partners as not subject to SE tax. (In this case, no part of the compensation to the limited partners was “guaranteed”.)
The Fifth Circuit reversed a pro-IRS 2022 decision in which the Tax Court found that even though Sirius’ limited partners were limited partners under applicable Delaware law, they should not be treated as “limited partners” for purposes of the LP Exception since they operated in a manner beyond those of “passive investors”. In reaching its decision, the Tax Court agreed with the IRS position that requires a functional analysis of the actual activities and level of participation by the limited partners in the business of the limited partnership. Specifically, the 5th Circuit rejected the need for a functional analysis that requires a case by case evaluation of the nature of the activities of the limited partners of a limited partnership in support of the entity and ruled that the term “limited partner” for purposes of the LP Exception means a partner in a state law limited partnership that has limited liability under the statute’s plain meaning. Otherwise, the guaranteed payment exception to the LP Exception is moot. Sirius is the first federal appeals court to address the IRS position that the intent of the LP Exception was to exempt any “passive investor” from liability for self-employment taxes and requires a functional analysis to determine the nature of the limited partner’s activities on behalf of the limited partnership.
Although the specific issue addressed in Sirius will likely be appealed to the U.S. Supreme Court, this decision is limited to entities organized as limited liability partnerships (LLP’s) or as limited liability limited partnerships (LLLP’s) and does not apply to those organized as professional limited liability partnerships (PLLP’s) or limited liability companies (LLC’s). Presumably, this also means that it will not apply to practice groups organized as PLLC’s. As a result, the guidance I provided in my prior article comparing practice group offers remains the same notwithstanding the Sirius appellate decision. Practice groups and those providing services to practice groups should follow this decision closely to see if further appellate court guidance is provided that could be relied upon by practice groups organized as PLLP’s.