Fifth Circuit Court of Appeals Hands IRS Defeat in Limited Partner Definition Case

On Jan. 16, 2026, the Fifth Circuit Court of Appeals published its decision in Sirius Solutions, LLLP  v. Commissioner (Case No 24-60240), which handed the IRS a significant defeat in its efforts to treat state law limited partners as general partners for purposes of imposing self-employment tax on their partnership distributive shares. With this decision, individuals who previously paid self-employment tax on distributive shares with respect to limited partner interests may now consider filing refund claims. Furthermore, partnerships may consider this decision in potentially reaching new filing positions about the extent of its allocations to limited partners that must be classified as net earnings from self-employment (NESE).

Background

Sirius Solutions, LLLP (Sirius) is a limited liability limited partnership formed under Delaware law, which provides business consulting services in Texas and London, England. Under Delaware law, the liability of its limited partners is limited to their investment, giving them protection from claims by creditors brought against the company and its owners. However, during the years at issue (2014-2016), several of these limited partners performed significant services for the company.

Sirius did not treat all of the limited partners’ distributive share of partnership income as NESE on its tax returns. This meant that the individual partners likely did not pay Self-Employment taxes or the 0.9% Additional Medicare Tax on those earnings. Note that the Self-Employment tax rate is 15.3% on taxable earnings up to the annual Social Security cap, with 2.9% on any earnings in excess of the cap. Federal income tax on those earnings was not an issue.

In doing so, Sirius relied on section 1402(a)(13) of the Internal Revenue Code which provides an exemption from self-employment tax for “…any item of income or loss of a limited partner, as such, other than guaranteed payments…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.” Sirius’s position was that since the partners were limited partners under state law, they were limited partners for purposes of self-employment tax on their partnership distributive share allocations, other than guaranteed payments for services rendered.

What did the Court Say?

Although the Fifth Circuit discussed many canons of statutory construction and other arguments, it ultimately ruled that a “limited partner” in section 1402(a)(13) is “a partner in a limited partnership that has limited liability.”

The two judges in the majority opinion (there was a single dissent) started out by looking at the plain text of section 1402(a)(13). Since Congress didn’t provide a definition for “limited partner,” the Fifth Circuit turned to dictionary definitions existing at the time the law was enacted in 1977.

The key feature under each of the dictionaries’ definitions of “limited partner” was limited liability. Moreover, a limited partner’s liability for partnership debts is limited to their investment in the partnership.

The Fifth Circuit also looked at the IRS’s own instructions to Form 1065 which, beginning in 1976 and continuing for more than 40 years, including the years at issue, defined a limited partner as “a partner in a partnership formed under a state limited partnership law, whose personal liability for partnership debts is limited to the amount of money or other property that the partner contributed or is required to contribute to the partnership.”

Even after the IRS changed the form instructions beginning in 2022 to add verbiage suggesting that a limited partner may mean something else, it did not provide a different definition or other material guidance on the term’s meaning. The Fifth Circuit therefore found that the IRS’s own form instructions were especially useful to discern the term’s meaning.

The Fifth Circuit also looked at the Social Security Administration (SSA) definition, which it found relevant because of the correlative relationship between Social Security benefits at retirement and the amount of self-employment tax paid during working years. The Fifth Circuit noted that under the SSA regulations, “You are a ‘limited partner’ if your financial liability for the obligations of the partnership is limited to the amount of your financial investment in the partnership.”

The Fifth Circuit summarized the following with respect to the “limited partner” definition for purposes of section 1402(a)(13):

The Fifth Circuit emphasized the fact that for over 40 years, the IRS’s own form instructions provided a conforming definition of limited partner. By requiring limited partners to undertake a functional analysis test (pursuant to the Tax Court’s 2023 decision in Soroban Capital Partners LP v. Commissioner), the Fifth Circuit questioned how state law limited partners were supposed to determine their self-employment tax without hiring “an army of lawyers and accountants — and a whole lot of luck.”

Where Are We Now?

The Fifth Circuit’s decision is precedential for taxpayers within that jurisdiction (Louisiana, Mississippi, and Texas). Partnerships and limited partners would likely lose in an action before the Tax Court (appealable to a Circuit Court other than the Fifth Circuit), if the facts aren’t heavily in their favor; however, such taxpayers may nevertheless consider the Fifth Circuit’s decision in evaluating whether they have substantial authority to report their NESE consistent with the Fifth Circuit’s decision. This is because filing positions may consider the weight of any court’s decision (the Fifth Circuit is the only Circuit to have addressed the issue), as well as the likelihood of success on appeals in other Circuit Courts or the U.S. Supreme Court.

It is possible that the IRS could petition the Fifth Circuit for a rehearing en banc, with all judges in that circuit participating in the decision, not just the three original judges who heard the case. While the court is not required to grant such a request, if it does, it is possible that the entire court, comprised of 17 active judges, could overturn the current decision. A petition for rehearing en banc must be filed by the IRS within 45 days of the decision under Federal Rules of Appellate Procedure 40(d)(1).  Note that the Fifth Circuit Rule 40 provides that “FEWER THAN 1% OF THE CASES DECIDED BY THE COURT ON THE MERITS ARE REHEARD EN BANC; AND FREQUENTLY THOSE REHEARINGS GRANTED RESULT FROM A REQUEST FOR EN BANC RECONSIDERATION BY A JUDGE OF THE COURT RATHER THAN A PETITION BY THE PARTIES.”  The IRS could also “nonacquiesce” in the decision, which generally means that it will continue to fight in other Circuits.

There are currently appeals also being heard in the First Circuit (Denham Capital Management LP) and Second Circuit (Soroban Capital Management, LP) on this same issue. It is possible that one or both of those circuits could come to a different conclusion.

Relevance of Sirius Decision on LLCs and their members

LLCs and their members should be cautious about placing significant reliance on the Fifth Circuit’s decision in Sirius Solutions. The Fifth Circuit made it clear that “…a ‘limited partner’ in [section] 1402(a)(13) is a limited partner in a state-law limited partnership that is afforded limited liability” (emphasis added). The Fifth Circuit reserved judgment with respect to members of LLCs and LLPs. Because neither LLCs nor LLPs are state law limited partnerships, the section 1402(a)(13) exception may not literally apply even though such members may enjoy limited liability.

Therefore, taking an expansive view of the Fifth Circuit’s decision to apply in these other settings is uncertain.

What Steps Can Taxpayers in this Situation Take?

Limited partnerships and their limited partners may want to consider the Sirius Solutions decision as substantial authority for the position to treat a distributive share of business profits to state law limited partners as being exempt from NESE. This is especially true for partnerships and individual limited partners in Louisiana, Mississippi, and Texas, but taxpayers in other states may also be able to rely on it (pending the outcome of legal challenges in other jurisdictions).

Note that substantial authority is only applicable for purposes of avoiding potential negligence and substantial understatement penalties. The ultimate resolution of a self-employment tax dispute – especially in jurisdictions outside the Fifth Circuit – will depend on the facts and circumstances and the relevant legal precedent.

All taxpayers who have paid self-employment tax on their distributive share of partnership income (other than from guaranteed payments) in a year for which the statute of limitations for refunds is still open should consider filing claims for refund. Furthermore, partnerships may now consider possible new filing positions about the extent of allocations to limited partners that must be classified as net earnings from self-employment (NESE).  Because any changes involve partnerships and partners, taxpayers will need to understand whether both the partnership (through an AAR) and the partner need to file amended returns, or whether partners may take an inconsistent position to expedite the amended return process.

Should you have any questions about the implications of this case, please contact your CBIZ tax professional.