In this episode of How Tax Works, host Matt Foreman discusses self-employment taxes, the ongoing tax saga of a hedge fund’s partners trying to convince the IRS that they are “limited partners, as such”, and the somewhat-related Net Investment Income Tax.  This episode is for anyone who is starting, operating, structuring, or wondering about how income tax structuring interplays with other kinds of taxes.

Please also see Matt Foreman’s upcoming webinar! Link below:

• Tax Strategies for Limited Partner Investors in Private Investment Funds
  November 14th, 2024 @ 1:00pm – 2:30pm EST

Listen to the episode here:

  

Follow us on Twitter: @HowTaxWorks

How Tax Works, hosted by FRB Partner Matthew E. Foreman, Esq., LL.M., delves into the intricacies of taxation, breaking down complex concepts for a clearer understanding of how tax laws impact your financial decisions. Through this, listeners are treated to a comprehensive breakdown of entity structures, from the robust shield of C corporations to the flexibility of partnerships and LLCs. Foreman navigates through the maze of tax considerations, shedding light on entity-level taxation, shareholder responsibilities, and nuanced tax strategies. Foreman shares valuable insights and practical advice, emphasizing the need for informed decision-making and consultation with tax professionals. From qualified small business stock to state and local tax considerations, no stone is left unturned in this illuminating exploration of tax law and entity selection.

Whether you’re a seasoned entrepreneur, accountant, lawyer, or financial advisor, “How Tax Works” offers a wealth of knowledge to empower you in making sound business decisions. Tune in and embark on a journey to unravel the complexities of tax law, one episode at a time.

This podcast may be considered attorney advertising. This podcast is not presented for purposes of legal advice or for providing a legal opinion. Before any of the presenting attorneys can provide legal advice to any person or entity, and before an attorney-client relationship is formed, that attorney must have a signed fee agreement with a client setting forth the firm’s scope of representation and the fees that will be charged.

Transcript:

**This transcript has been prepared automatically by AI and may contain inaccuracies**

Matthew Foreman [00:00:00]:
Welcome to the 11th episode of How Tax Works. I’m Matt Forman. In this episode, I’m going to attempt to explain Soroban Capital Partners LP versus Commissioner, which is about the least interesting area of income taxes, self employment taxes. However, despite that is actually a very interesting, very nuanced case that revolves around four words and a comma and the definition of those four words. And I will discuss in some detail, I’m sure, the importance of being good at drafting and thinking through problems from what can happen now and later, which is sort of what happened with Congress. I got whipsawed a bit How Tax Works is meant for informational entertainment purposes only. This may be attorney advertising and it is not legal advice.

Matthew Foreman [00:00:55]:
Please, please, please hire your own attorney. How Tax Works is intended to help listeners navigate the intricacies and complexities of tax law, regulations, case law, and guidance to demystify how taxes shape the financial and business choices that we all make before we get started. A few Administrative Things episodes every two weeks. The next episode is going to talk about SORB and Capital Partners. Again, I’m too verbose and it is a really interesting case, but in my defense, I’m going to be talking about a Tax court decision and two briefs that were each about 80 pages. So it’s tough to really get it in. There’s a lot packed in. So talking about that again, if you have any questions, comments or constructive criticism, you can email me at my FRB email address.

Matthew Foreman [00:01:35]:
You can find me your favorite search engine. Ask G is of course always the best. November 14th from 1 to 2:30pm Eastern Standard Time. There’s a Stratford webinar in which I’ll be presenting with another partner at the firm does cost money, but you get cle, CPE and ce. So if you need one or all three or you just want to hear me talk again just a little bit about Sorbonne Capital Partners, but I’ll talk about a lot of structuring and other things that I do. The link will be on the web page on the FRB page for it. The title is Tax Strategies for Limited Partner Investors in Private Investment Funds. Like I said, this episode is going to be two parts 11 and 12.

Matthew Foreman [00:02:12]:
The overview is basically four parts. Okay, one self employment tax to Sorbonne Capital Partners versus Commissioner. Right. The the IRS case, sorry, the tax Court case. And we’re going to talk about, you know, limited partner in name only. What came out of that? Then we’re going to talk about three other cases that dealt with it. Rank, Myer, Harding, Castiglia. I’M probably at that point going to pause.

Matthew Foreman [00:02:37]:
That’s probably. We’re going to break. We’ll see what the time ends up being and go to the next episode. Next episode we’ll go to a quick overview. But really you should listen to both probably at once or close to it and talk about the arguments made by the taxpayer and arguments made by the irs, both of which I actually think are correct. The rare situation where I’m like, boy, both of them really make a good point. So that’s, that’s always fun. Then I’m going to talk about the net investment income tax.

Matthew Foreman [00:03:00]:
I’ve heard it called the neat. I didn’t know that. It sounds sort of like the knights who say knee, which I will not say. But if you know the reference, congratulations, wonderful film. But you know, talking about it, its interplay with 469 and the interplay of the net investment income tax and self employment tax, how they overlap, how they don’t overlap and why Sovereign Capital partners probably isn’t too worried about it. And then I’m going to ask some closing musings. What do I actually think? Where will this go? You know, hold on to your seats, I’m sure I’ll say something crazy. All right, so first off, you know, I think it’s helpful to have a definition.

Matthew Foreman [00:03:33]:
What is the self employment tax? Right. Self employment tax came under the Self Employment Contributions act. Seca. Seca maybe seca, I don’t know. It requires owners of businesses as corporations, partnerships, sole proprietorships, anything that’s a pass through to pay employment taxes. 15.3% of their net income from self employment workers. There’s a caveat. I’ll get to that in a second.

Matthew Foreman [00:03:56]:
Workers who are employed by a company or another person pay half via withholding and the employer pays the other half. So the total is 15.3. If you’re an employee, you get a W2 and you’ll see that there is half of 15.3. Right. So you know, you pay half, employee pays out. What happens is basically for self employment taxes, the function of what you get is basically you pay both halves and then you get to deduct 1/2 as if you’re an employer. Right. Self employed.

Matthew Foreman [00:04:21]:
That’s the idea. The way that they function is really two taxes under section 1401 of the Internal Revenue Code. 1401A is the Old Age Survivors and Disability Insurance OASDI, which is 12.4% and section 1401 is Hospital Insurance or HI, which is 2.9%. The OASDI has a cap. You can Google to find out what the cap is. The Social Security Administration has. I’m sure the IRS has it. They actually just released a.

Matthew Foreman [00:04:49]:
It’s a revenue procedure. I’m not totally sure that says what it’ll be in index for inflation. It was actually statutorily set every single year until 1981. They did it a couple years and, you know, they book out a couple years and things like that. But it was 29,719 81, 2016, it was 1185-0020-1712-7200. Those are the years at issue, in case you’re wondering. 2024 is 168, 600 and 2025 next year. Talking about the future here.

Matthew Foreman [00:05:19]:
176,100. The hospital insurance amount. Hi. It does not have a cab. It goes forever. AT is at issue here in Sorbonne Capital Partners. So 1402A defines net earnings from self employment. It’s not all income.

Matthew Foreman [00:05:35]:
Right. It is gross income from a trade or business plus a distributive share. Distributive share, of course, is defined under section 702A8 of the Internal Revenue Code. And that’s. That’s what is subject to this quote, unquote, self employment taxes under section 1402 A13. It was A12 when passed. So if you ever, you read the Congressional Record or other things, references a 12 with the same language. That’s important to note that that’s where you know, that’s what it’s talking about now.

Matthew Foreman [00:06:04]:
It’s a 13 has been amended. This happens fairly often. Obviously, the law was from 1977. So the whole code changed, you know, went from the code of 54 to 86. And that anyway, 1400 2A13 reads. And I apologize, I’m going to read it here. I’ll explain to you what matters. There shall be excluded from the distributive share of any items of income or loss of a limited partner as such, other than guaranteed payments described in section 707 to that partner for services actually rendered to or on behalf of the partnership to the extent that those payments are established to be in the nature of remuneration for those services.

Matthew Foreman [00:06:43]:
What does that mean? Exclude from CECA any item of income of a limited partner as such, other than guaranteed payments. That’s how I read it. That’s the shortened one. The entire fight here is over four words and a comma, limited partner as such. What does that mean? Do we know what A limited partner is. And what does as such actually mean? What are we trying to accomplish there? What does that say? Okay, so the first step in any time you’re trying to understand unclear language, you look at, well, what is, what do the words say? You look at it, you say, I don’t know what that means. I really, I don’t know. No one knows.

Matthew Foreman [00:07:19]:
Anyone says, well, it obviously means based on the verbiage, at least in this context, is lying to you. It’s unclear language. It’s not great drafting. It was also important to note that at the time, you know, the congressional intent, the prior law, the distributive share of a limited partner was actually included in net earnings from self employment. State of El Sasser versus Commissioner 61 TC 241, 1973 cases. So Congress actually said, you know, it really shouldn’t be. All right, A limited partner really shouldn’t. And the premise was, well, we don’t want them actually part of the Social Security, paying into Social Security, getting out from it for being a limited partner.

Matthew Foreman [00:07:56]:
That’s not the point. So they passed a section 812 subsection a 12. Now a 13. Right. House reporter. If you ever want to read it, you can. If you Google, you know, if you Google Sorbonne Capital Partners, it’ll, it’ll point you to it. If you want to read the reprint, it’s in 1977 US CCAN 4155.

Matthew Foreman [00:08:14]:
It’s in page 4197-98. That’s what discusses it. But I’ve basically going to explain to you everything that’s there anyway, so don’t, don’t worry about that. The next big thing is the structure of Sorbonne Capital Partners. It is an extremely typical fund structure. You have three partners at the top. They’re individuals to own through single member LLC that are disregarded for income tax purposes. And if you don’t know what discredited entities are, highly recommend.

Matthew Foreman [00:08:42]:
The first episode of my podcast I talk about it. They own 100% of a general partnership of, of an LLC, Sorbonne Capital Partners GP, LLC. It is taxed as a partnership. I don’t actually know how they own it. I think it’s a third or third or third. But it might actually be the same way they own the sole thing that SVP LLC owns. Right. Or the main asset that’s relevant here is Sorbonne Capital Partners lp.

Matthew Foreman [00:09:08]:
Right. I’m going to call that Sorobond. All right. The GP I’ll refer to as the general partner. That’s The LLC and the lp. The actual, you know, operating entity herein is SCP lp, that’s Sorrel Bond. It is intentionally a limited partnership. I will talk about that in a sec.

Matthew Foreman [00:09:27]:
The way that income is earned by Sorbonne Capital Partners lp, okay. They have a number of funds. Sorbonne Master Fund lp. Sorbonne Opportunities Master Fund lp. Those funds pay fees to Sorbonne itself. The funds pay fees based on an assets under management in exchange for investment management services. That’s it. Fees for services.

Matthew Foreman [00:09:50]:
That’s. That is the crux of it. That’s what’s going on. Not really disputed. Different parties. The IRS going to hang its hat a lot more on the fact that it’s compensation for services provided Soroban through their attorneys, they lessen it. They talk about other things. What’s going on, you know, why it’s done.

Matthew Foreman [00:10:09]:
The two funds have a lot of LPs that are not at issue here because they’re true limited partners. The three people at issue are the three individuals who own both 99% in the LP and they own 100 of the GP which owns 1% of the LP. That’s the issue the way that those people are compensated. Those three individuals, emg, K, sf. You can look up their names if you want. I’ll probably mention them later when I talk about them in a bit. But the way they’re compensated is two ways. One, they have guaranteed payments which I’ll talk about how that’s determined and the amounts and they receive a distributive share.

Matthew Foreman [00:10:44]:
Anyone who knows anything about income tax knows that that doesn’t mean that’s how much money they actually got. That’s just how much money on which they are taxed. And I think it’s really important to point out that important fact and the lead of it. Capital accounts. Capital accounts are really important. Capital accounts, I say it are the engine of partnership tax. That’s really important here too. So sorry about this structure.

Matthew Foreman [00:11:07]:
Right. I already talked about this. Right? There’s four partners, the three individuals and the gp. But there’s really only three beneficial owners. There’s some disregarded entities. The LLC is the general partner. Each partner earned income in two ways. The amounts of guaranteed payments are slightly different for each one.

Matthew Foreman [00:11:22]:
They’re a little over $400,000 per year each a little over one, like 1.22 then 1.26 million total in the two year 16, 2017. And those amounts are subject to self employment tax. Guaranteed payments are absolutely subject to self employment tax. The distributive shares at issue Here. And this is what Soroban is saying are excluded from self employment. The IRS is saying, no, no, no, not so fast. There will be self employment tax on it. The distributed shares for 2016 was 77.6 million.

Matthew Foreman [00:11:51]:
Again, three partners. And then in 2017 it was 68.3 million. The distributions were actually a lot lower. They’re like 29 and 50 million. I mean still a huge amount of money, don’t get me wrong. But they’re actually lower amounts. So not everything was distributed. And that, that’s important later.

Matthew Foreman [00:12:08]:
I’ll get to that in a second. And the employees were extremely highly compensated as well. There were 20. If my memory’s gonna be right. I’m not to the page where I have this in my notes, but I believe they had 25, 27 employees in 2016. And they had 25 employees in 2017. And they were compensated $26 million in 2016 and $49 million in 2017. The employees were not poorly compensated individuals.

Matthew Foreman [00:12:33]:
They did very well for themselves. I don’t say this is a small fund. I think that’s mean. But this is not like a fund with 400 people. This is a fund where everyone knows everyone’s name. You know, they’re talking to everyone. They’re really involved. This is, this is someone they do it.

Matthew Foreman [00:12:47]:
I’ll get into more into that in a little bit. I know I keep saying I’ll get more into it, but I don’t want to. I don’t want to jump ahead of myself and ruin my notes. So the three individuals em is Eric Mandelblatt, managing partner and chief investment officer. He is the only individual who actually contributed cash. He contributed millions of dollars. They don’t have number in front of me like $3 million total. The other two contributed know how I put in my notes or did they? Right.

Matthew Foreman [00:13:14]:
And you know, anyone who’s ever dealt with a service partnership knows that sometimes people put in money and others don’t, right? And so the question becomes, is that a shift in income? Is that section 61? Is that section 83? Go back a couple episodes and you’ll say, well, maybe. So the argument made was that Gaurav Kapadia and I apologize for mispronounce his name. He his title is the co managing partner. And Scott Friedman, who does not appear to actually have a title. He’s sf he is the head of risk management and trade execution. But he doesn’t have a formal title like the other two dude did a lot of people in the fund didn’t seem to actually have formal titles. Really. The two of them, GK and sf, they contributed know how.

Matthew Foreman [00:13:54]:
However, there were no documents saying that they contributed. And it’s unclear whether if they left they would get back their know how. How do you give back know how do you distribute it? What’s the value? Is it taxable? What about, there’s a whole host of things, right? It’s a partnership, not an S corp, so it’s unlikely to be taxable. But the IRS cast some aspersions about it. They’re like, you know, Sorbonne in their brief says, oh, you know, they contributed know how, it’s very valuable. And even though they didn’t contribute cash, it’s very valuable. And the IRS says okay, well where’s your document saying you contributed capital? Oh, there is none. Okay, well that’s, that’s helpful.

Matthew Foreman [00:14:32]:
That’s great. Good job people. Right. So you know, anytime you’re making an argument, try to have documents, try to have proof, you know, contemporaneous documentation is very helpful. So anyway, back to my, you know, actual analysis. Day to day managerial responsibilities for the three of them are consistent with C suite executives. What’s interesting about this case is in the briefs, the facts are basically agreed upon. The law is largely agreed upon.

Matthew Foreman [00:15:01]:
The application, 80% agreed upon. But that 20%, that last 20%, woof, boy, it is, it is two people going in different directions and seemed confused as to why one would turn one way, one would turn the other. Anyway, so their managerial responsibilities consistent with C suite executives, they managed the funds, they provided investment advice. They used daily reports to monitor risk exposure, profit and loss. They did extensive, extensive, extensive analytical work that is beyond described in it. And they made trade orders, right? So they said, this is how we’re trading, this is what we recommend, this is what we’re doing. One thing that came out from the pleadings and I did some this and googling, whatever as one does is the three largest stocks actually held by Soron Capital Partners because they have to file documents with the sec. And they’re a registered investment advisor.

Matthew Foreman [00:15:52]:
Regulated investment advisor. Registered. Let’s see. They are a registered investment advisor. All right, I’ll get that right one of these days. So they have to disclose it. The three top ones are Microsoft, csx, Union Pacific, maybe it’s two train companies in Microsoft. So I thought that was interesting, not giving any stock tips.

Matthew Foreman [00:16:09]:
I have no idea what I’m doing here. But you know, who knows? Maybe they actually out earned the s and P500 or maybe they don’t right. So the three of them, Em, GK, SF, right, had the power to hire, fire, promote and evaluate employees, and they were allowed to and did delegate different authority in that. One thing I thought was really interesting is every single person at the fund, right, at Soroban, interviewed every single candidate. So if you want to work there, you’re going through 25 interviews. Maybe it’s fewer, maybe there’s two at one which. Three at one, which may be better, maybe worse. I don’t.

Matthew Foreman [00:16:44]:
I don’t know. I’m not really sure, but that’s interesting. Anyway, the three of them estimated they worked between 2000-320-500 hours per year. For those doing math, that’s. That’s somewhere between 45 and 50 hours a week, every week, and it was 100% of their time. I suspect those numbers might be low. Both the IRS and Sorbonne cited those numbers and seemed to not really doubt the numbers. They both basically said, look, this is all they really did.

Matthew Foreman [00:17:09]:
This was their job. You know, they had. They had side projects in terms of volunteering, and they had families and things like that. But this, this is. This is their focus. They’re making a lot of money, they’re doing a lot of stuff. This is really. This is what they’re focusing on.

Matthew Foreman [00:17:23]:
So the three of them, they also served on committees, right? There were five committees, four in 2016, one that was added for 2017. Brokerage, trade, allocation, valuation. I’m sorry, Brokerage, trade allocation, valuation and management were the four. And then there was a fifth committee added in 2017, cyber security. None of the three of them served on the Cyber Security committee. I suspect that their general counsel, who’s also their chief compliance officer, headed that committee or was on it at some level, but they didn’t have anything to do with it. They were focusing on the core business. Although cybersecurity is business, you know, the important part of any.

Matthew Foreman [00:17:56]:
Any company. So, you know, I thought that was interesting. In the documents to investors, the PPM’s private placement memoranda, various SEC filings, they described the careers and timelines, the extensive experience, their. Their phrase, extensive experience, and said that the success of the fund will depend on. On the skill and expertise of the principals. The principals. The principals. Now, you know, saying that the principals and the people in charge and those in charge of things, that’s going to be, you know, the reason the business is going to be successful or unsuccessful.

Matthew Foreman [00:18:29]:
Right. They never say unsuccessful is standard, but they kept talking about the skill and expertise of the principals, and they kept calling Them principals, they didn’t call them partners, they didn’t call them owners. They didn’t say the co managing partner, they didn’t say the head of trading. And I felt the word choice is interesting. They keep hammering on the point of principles and that’s one thing that, that I thought was interesting. They talked about, you know, the three individuals. Principles, principles, principles and I think emphasizing their role as principals and not as, you know, the principles of the general partner which controls limited partnership, but also they hold ownership interest as limited partners directly in the business. They didn’t sort of go into that when talking about that issue.

Matthew Foreman [00:19:09]:
I, I think it’s really interesting in describing their role especially as how to, how everything works out. Okay, so let’s take a, let’s take a quick break. When we come back, we’re going to talk about the 2023 Tax Court decision. All right, so section 1402 A13 excludes income earned by limited partners as such from net earnings from self employment. Never thought we’d get back here. Right. The partners who actively participate in a state law limited partnership are not necessarily limited partners as such. Those partners are subject to self employment tax if they are a limited partner in name only.

Matthew Foreman [00:19:50]:
Right? Limited in name only, they kept saying. And they’re not subject to CECA if they are functioning as a limited partner. But of course the Tax board did not actually propose a test. Self employment earnings are excluded if they are mere investments. This is why the actual LPs, the people who have nothing to do with the operation of the fund, they’re not worried about them. That’s it. There are three cases of note. Two were mentioned in the Tax court decision.

Matthew Foreman [00:20:14]:
Third comes up because it parallels it. There’s Reink, Meier, Campbell Weaver LLP vs Commissioner 136 TC137 from 2011 in Renk Meyer, it was lawyers who were partners and were limited partners in the partnership. Right. Limited liability partnership. They were limited partners. They were lawyers. They were partners. It does not appear that they had associates.

Matthew Foreman [00:20:35]:
I haven’t read the case in a couple weeks so I’m not hunting on it. But the idea was basically look like you are limited in name only. You are just really doing a crappy job on this. So you don’t get it. There’s Castagliola vs Commissioner TC Memo 201762 law firm but all LPs same same facts as Rank Meyer. The other case, the one that went the other way is Hardy versus Commissioner TC Memo 2017 16. So same year as Castigliola Dr. Hardy was a surgeon.

Matthew Foreman [00:21:04]:
He performed surgery for a limited partnership. The limited partnership was a whole host of Doctors. Dr. Hardy had no managerial control whatsoever. And that, that right there is the important, the most important, perhaps the important fact. Okay, that he had no managerial control. He just came in, did his surgery, took his money and went out and did whatever doctors do when they’re not during surgery, which I assume is take naps, right. You know, read, read medical journals and take naps and we go to a sporting event, right? So, so that, those are the three cases that’ll come up again and again and again.

Matthew Foreman [00:21:39]:
So at this point we are going to talk about Soroban’s brief. We’re going to do it and then we’re going to take a break, two weeks, you’re going to come back and hear me talk about the IRS’s brief and you know, recap a little IRS’s brief and then talk about who is right. Because I think that’s an important point. So the principals are the partners in both Sorbonne, the LP and the Jet gp, which are both tax partnerships. One comment I always make is like, look, they’re both tax partnerships. Why does it matter what they are? Right. The LP agreement, the limited partnership agreement provides separate roles for the general partner and the limited partners, the principals who are again, you know, look again, there are no LPs in Sorobot itself that are not the three individuals. So when I say LPs I mean the same people who are running the show, right? The principals, LPs.

Matthew Foreman [00:22:29]:
Right. The only work permitted to be done and the only work that was done as LPs was what is allowed under Delaware LP statute. These are, every entity here is a Delaware entity. The limited partner return is a return on investment, even if there are minimal contributions. So it’s important to know that that is why it is exempted from self employment taxes. One point that Sorbon really made repeatedly and I thought was a really, really, really, really, really good point. Even though two of the three partners did not in fact actually contribute money, they had significant capital accounts in the briefs. It had the capital accounts and they were in the eight figure range.

Matthew Foreman [00:23:05]:
They were often exceeded eight figures. And I think that that’s really important to note that no, they didn’t put in money, but they weren’t taking out every penny and they were using their capital to run the business. So I think that’s really important. The principals as general partners, they earned a guaranteed payment, which were paid no matter what for services performed for the Limited partnership. Right. They flowed up through the general partner and then to the three owners. Guaranteed payments were determined prior to the years at issue, such as salary. Right.

Matthew Foreman [00:23:34]:
You know, similar to salary. So I think that that’s really an important point that, you know, the guaranteed payment wasn’t like, well, how can we, you know, go this way, go that way? Basically what they did was when they formed the fund, 2010, 2011, they took an amount, had a discussion with the CFO CEO, and they said, okay, this is how much the principals make as their guaranteed payment. That’s how much we’re getting paid, and the rest we’re going to make based on how great we are at providing services. Which doesn’t sound a huge lot amount like return on investment. But, you know, sometimes you provide services and eventually you get a return on investment. That’s how. That’s. That’s goodwill, right.

Matthew Foreman [00:24:14]:
In a lot of ways. So that’s the idea. So the argument made by Swarthmore Capital Partners in their brief is that the as such, in limited partners, as such, anticipates both a general partner and a limited partner being the same individual. And I think that’s true. I don’t think the IRS really disagrees with that conceptually. So I thought that was a really good argument. They made it in a really nice way. There is no statutory authority to require a functional test.

Matthew Foreman [00:24:37]:
And they have citations. They. They brought receipts like, you can’t just create a test out of nowhere. The test for whether you can create a test out of nowhere, of course, Marbury v. Madison, which, of course was out of nowhere. So it’s important to note that, you know, in the United States of America and prior to it, in other countries, judges and courts have been creating tests out of nowhere for forever. So anyone who says that, you know, judges just interpret the law, I think that’s. That’s false.

Matthew Foreman [00:25:01]:
I think there’s tests created no matter what you do, to determine how things are. That’s. That’s how it works. Sorbon suggested nine factors for a functional test. I am not going to go through them. You can read it. Shockingly, they create a positive result for Sorobond. You know, totally surprised, I know you are as well.

Matthew Foreman [00:25:17]:
So I think it’s important to just think about, okay, what is the functional test? But it’s important that they did one. They pointed out that there really is no authority. But if there is an authority, or if you think there should be one, here’s what you should do. You know, it’s what I always Tell people they’re starting their career. Anytime you go talk to your boss and you’re like, boy, I have a problem. Have a solution and have a solution that you like. Because they might go, that sounds okay, let’s do that. And they pointed out that most income is from management fees, and it’s from asset value, not specific activities and services.

Matthew Foreman [00:25:50]:
They didn’t quite say it the way I’m going to say it, but even if Sorbonne Capital Partners was awful at their job, they will get those management fees. And they did in later years. They had some really not good years a couple of years later and they still got their management fees. It’s based on assets under management. I don’t think they want to say that out loud, but it’s an important thing to know. They also pointed out that the employees generated this income. Right? There are 27 employees in 2016 and 25 and 2017. There are three extremely significant employees.

Matthew Foreman [00:26:19]:
And I didn’t write down their first names of courses. I didn’t prepare things that way. But there’s Tansy, who is the coo. CFO Johnson is the head of investor relations, and Nitich is the general counsel, chief compliance officer. I’m sure a wonderful human being since he’s a lawyer. And I think that that’s what they point out was like, look, the employees generated the income. And in that they were saying, well, this isn’t rank, Meyer. This isn’t just a bunch of, bunch of principals running around being both.

Matthew Foreman [00:26:44]:
No, no, no. This is hardy, right? Even though. That we’re partners, even though we’re doing all kinds of stuff. No, no, no, no, no. The income is really earned by other. Because everyone else does work. They didn’t totally dig into that. And they also didn’t really point out how the value was earned, what stuff other people did other than those three individuals.

Matthew Foreman [00:27:02]:
And I think the reason is because, look, you don’t want to point out that like some rank and file employee is just like a superstar and then put it into a document that you filed the tax court, that other funds can come along and say, boy, you know, this, this, this guy here is this woman here. She’s really something, you know, she’s really phenomenal. Let’s. Let’s hire her. I actually sort of, when thinking about this, I thought back and you know, you always. Anyone who does tax law and you created allergies. You sort of create frameworks. Well, that’s sort of like something else.

Matthew Foreman [00:27:32]:
And I, I keep, kept coming back to the concept of S. Corporation Reasonable compensation. I, I think a lot of this underlying problem is the fact that they got $1.2 million of guaranteed payments, I’m sorry, 2.5 million roughly in two years. And the amount of money that they got in allocations. Okay. Is $140 million. Their ratio is bonkers different. Okay.

Matthew Foreman [00:28:00]:
And I always thought that that was something that they sort of looked at and said, well look, you know, what should the number be? And I wonder to myself, and this was not brought up by either the IRS or sorry Bond because I don’t think they want to go down this path, even the IRS. But what if the guaranteed payments were $20 million? Is that more reasonable? Is that less likely to draw an eye? It would definitely lower the amount of money at stake for both sides. But it’s an interesting question. Is this heading towards limited partners as such being S Corporation reasonable compensation? I don’t know the answer to the question. I’m never going to know that answer to that question unless I email people and ask. But that’s it. That, that’s sort of what we’re going to go with. So this is where we’re going to pause here.

Matthew Foreman [00:28:42]:
About 20 something minutes in, I went straight, straight through. So you know, I think it’s a good one and I think it’s a good point to stop if you come back in two weeks. Right. This is, this was the 11th episode of how Tax Works. Hope you learned something. I’ll be back in 2 weeks 12 episode where I’m going to talk about Sorbot again and finish this thought process. I just didn’t want to have a 35 or 45 minute podcast episode. It’s already somewhat self aggrandizing to have a podcast in general.

Matthew Foreman [00:29:08]:
I didn’t want to think that someone would want to hear my voice for 45 minutes straight. Although maybe some of you are going to listen to both at once. I hope you enjoy it. So again, be back in two weeks with the second half of it.