Summary
On Tuesday, a Fifth Circuit panel substantially changed its interpretation of the “limited partner” exception in section 1402(a)(13) to one who “plays no significant role in managing or running a business.” The underlying issue is whether state-law limited partners qualify for the exception from self-employment taxes by virtue of their legal status, or whether qualification instead turns on the functions they perform for the partnership. Previously, the Fifth Circuit had held that a limited partner is a partner in a limited partnership that has limited liability.
The decision came in response to the Government’s petition for rehearing en banc in Sirius Solutions, L.L.L.P. v. Commissioner, 165 F.4th 374 (5th Cir. 2026). The Fifth Circuit denied the Government’s petition for rehearing en banc, but the original three-judge panel treated the petition as also seeking panel rehearing and granted that request. The panel withdrew its January opinion, and substituted a substantially revised per curiam opinion, now captioned K Alain, L.L.L.P. v. Commissioner, No. 24-60240 (5th Cir. Aug. 12, 2026). Although the outcome remains the same, vacate and remand, the substitute opinion materially changes both the standard applied and the reasoning supporting it. The Tax Court’s interpretation is also being appealed in other circuits in Denham Capital Management LP v. Commissioner, T.C. Memo. 2024-114, pending in the First Circuit, and Soroban Capital Partners LP v. Commissioner, 161 T.C. 310 (2023), pending in the Second Circuit.
Background
Section 1402(a)(13) provides:
- there shall be excluded the distributive share of any item of income or loss of a limited partner, as such, other than guaranteed payments described in section 707(c) 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.
The Tax Court has held in several cases, starting with Soroban and including Sirius, that determining whether a partner is a “limited partner” for section 1402(a)(13) purposes requires an analysis of the partner’s role in the partnership.
A divided Fifth Circuit panel held in its January opinion that a “limited partner, as such” for purposes of section 1402(a)(13) is a partner in a state-law limited partnership who has limited liability. Sirius, 165 F.4th at 378. Under that formulation, limited liability was the “touchstone” of limited-partner status, and the degree to which the partner participated in the partnership’s business generally did not alter the analysis unless that participation implicated the partner’s limited liability. The majority also relied on a longstanding Social Security Administration (SSA) regulation implementing the parallel SSA exclusion enacted alongside section 1402(a)(13), which defines a “limited partner” by reference to its limited liability for the debts of the partnership, as contemporaneous confirmation of its liability-focused reading. The January opinion, written by Judge Oldham and joined by Judge Engelhardt, rejected the functional analysis required by the Tax Court in Soroban, under which the exception was limited to partners functioning as passive investors. The January decision is further detailed in this S&C memo.
Fifth Circuit’s Substitute Opinion
The Fifth Circuit’s substitute opinion issued by the same panel holds that the “original public meaning” of “limited partner” is a partner who “plays no significant role in managing or running a business.” The revised opinion thus shifts the standard from an inquiry into state-law liability status to an inquiry that “turns on the role partners played in the enterprise.” The opinion does not identify where the line is between a permissible and impermissible role for a limited partner under section 1402(a)(13), only noting that, based on the “original public meaning” at the time of the statute’s enactment, a limited partner could not manage the partnership “but perhaps could participate in certain nonmanagerial aspects of the business.”
The substitute opinion reaches this conclusion citing definitions in the 1916 Uniform Limited Partnership Act, the 1976 Revised Uniform Limited Partnership Act, contemporaneous partnership treatises, and Plasteel Products Corp. v. Helman, 271 F.2d 354, 356 (1st Cir. 1959). The majority concludes that historical limited-partner status permitted “some participation in the business,” but not “a significant role in managing or running the business.”
The substitute opinion does not discuss the January decision’s prior framework. It no longer discusses the SSA analysis, but instead points to the IRS’s long-standing limited-liability guidance. State law is no longer discussed. Whereas the January opinion treated state-law limited-partner status and limited liability as largely controlling, the substitute opinion treats the meaning of “limited partner” as a federal question and makes the partner’s “managerial” role in the business central to the inquiry.
Judge Graves dissented, stating that “the text and structure of 26 U.S.C. § 1402(a)(13) are clear that its tax exemption for limited partners applies only to those functioning as passive investors,” and that he therefore would affirm the Tax Court.
Because the panel withdrew its prior opinion and substituted a new opinion on rehearing, the taxpayers may file a new petition for panel rehearing, rehearing en banc, or both, which must be filed within 45 days after entry of the substitute opinion.