Fifth Circuit Overturns Tax Court in Limited Partner Case in Sirius Solutions

On January 16, 2026, the Court of Appeals for the Fifth Circuit in Sirius Solutions, held in a split decision that the “limited partner” exception to the self-employment tax applies to a partner in a limited partnership who has limited liability under state law.[1] The court therefore vacated the Tax Court’s decision that, in accordance with the Tax Court’s decision in the earlier Soroban case, had limited the exception to “passive investors” and applied a functional inquiry into partner activities to determine whether the exception applied. The same question concerning the application of the exception is currently before the First and Second Circuits in the Denham and Soroban cases, respectively.[2]

Background

The Self-Employment Contribution Act imposes a tax on earnings from self-employment, comparable to the tax imposed by the Federal Insurance Contribution Act for wages.[3] For partners, self-employment income generally includes the partner’s distributive share of trade-or-business income carried on by the partnership. The statute does, however, provide an exception for limited partners in a partnership.

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.

In a 2023 opinion, Soroban Capital Partners, the Tax Court held that determining whether a partner is a “limited partner” for section 1402(a)(13) purposes requires a functional analysis of the partner’s role in the partnership.

Sirius Solutions (a Delaware limited liability limited partnership) operated a consulting business and treated its partners’ distributive shares of partnership income as excluded from “net earnings from self-employment” under § 1402(a)(13).

As in several other recent cases the IRS took the position that the partners did not qualify as “limited partners” for purposes of section 1402(a)(13). In order to facilitate the appeal to the Fifth Circuit, Sirius stipulated that Soroban was precedential in the Tax Court and that, under the functional analysis test, the partners would not qualify.

Fifth Circuit’s Majority Opinion

In an opinion written by Judge Oldham (joined by Judge Engelhardt), the Fifth Circuit held that “limited partner” means a partner in a limited partnership with limited liability under state law, consistent with ordinary meaning and contemporaneous usage, and does not mean a partner that is “passive” under a judicially created test. The majority relied on contemporaneous definitions and common legal usage describing a “limited partner” primarily by reference to its limited liability status (as contrasted with a general partner’s unlimited liability). The opinion noted that long-standing IRS materials (including IRS instructions with respect to tax forms over many years) aligned with this interpretation, reinforcing the majority’s reading. The court rejected the Tax Court’s approach that effectively limits § 1402(a)(13) to passive investors.

The majority opinion squarely addressed, and rejected, the IRS’s position and the Tax Court’s reasoning in Soroban, identifying three principal flaws in the view that section 1402(a)(13) limits the term “limited partner” to a purely passive investor.

First, the majority concluded that a strict passive-investor definition is incompatible with the statute’s guaranteed-payment carveout. Section 1402(a)(13) excludes a limited partner’s distributive share from net earnings from self-employment but expressly includes guaranteed payments made to limited partners for services. The court reasoned that if “limited partner” were defined to prohibit any service activity, the guaranteed-payment provision would be rendered superfluous.

Second, the court observed that Congress could have expressly adopted a passive-investor standard had it intended to do so. Instead, Congress used the established legal term “limited partner,” which, at the time of enactment, was commonly understood to describe a partner with limited liability, not a partner defined by the degree of activity or passivity.

Third, the majority noted that adopting a functional, activity-based test would introduce significant uncertainty for taxpayers, requiring them to assess self-employment tax exposure based on fact-intensive and potentially indeterminate evaluations of their day-to-day activities.

The majority was also unpersuaded by the Tax Court’s interpretation of the phrase “limited partner, as such.” In Soroban, the Tax Court concluded that this language limits the exclusion to income earned by a partner acting in a limited (that is, passive) capacity. The Fifth Circuit disagreed, characterizing “as such” as “recursive,” effectively meaning “a limited partner, in the capacity of a limited partner.”[4] In the majority’s view, the phrase does not independently impose a passivity requirement, and contemporaneous dictionary definitions and administrative guidance do not support equating “limited partner” with “passive investor.”

Practical Implications

There remain two ongoing appeals of the Tax Court’s interpretation of the limited partner exception: Denham Capital Partners in the First Circuit and Soroban Capital Partners in the Second Circuit. The outcome in those cases is pending, and a decision for the Commissioner in either case would result in a Circuit split.

Thanks to the procedural practice known as the Golsen[5] rule, the Tax Court will generally follow its own precedent unless a case is appealable to a circuit court in which there is a contrary circuit court opinion squarely on point to the question presented. Thus, cases appealable to the Fifth Circuit must follow the Fifth Circuit’s opinion in Sirius Solutions, but we can expect, at least for now, that the Tax Court will continue to follow Soroban in cases that would be appealable to other circuit courts. However, if all three circuits reject the Tax Court’s interpretation, it is possible that the Tax Court may reconsider its reliance on Soroban.

Sirius Solutions may offer support for the argument that since § 1402(a)(13) turns on limited-liability status (not on a functional “services” or “passivity” test), similarly situated owners in other limited-liability entities should likewise be eligible for the exception in § 1402(a)(13) by reason of their limited liability status. The Tax Court had previously held in Renkemeyer[6] that in the context of entities treated as partnerships for tax purposes but that are not state law limited partners (e.g., LLCs or LLPs), a functional “services” or “passivity” test applied. Sirius Solutions may encourage taxpayers to challenge that holding.