On Aug. 12, 2026, the Fifth Circuit withdrew its Jan. 16, 2026, opinion in Sirius Solutions LLLP v. Commissioner, now captioned K Alain, L.L.L.P. v. Commissioner, and issued a revised opinion addressing the limited partner exception to self-employment tax under Section 1402(a)(13). The withdrawn opinion had taken a state law approach, concluding that limited partner status and limited liability were sufficient. The revised opinion instead adopts a functional standard focused on whether the partner plays a significant role in managing or running the business. This functional standard is essentially the same as the one formulated in 2023 by the Tax Court and affirmed on Sept. 17, 2026, by the Second Circuit in Soroban Capital Partners LP v. Commissioner.
What the Fifth Circuit Said About the Limited Partner Exception
In its revised decision, the Fifth Circuit made clear that it does not accept the IRS’s broad functional view of limited partner status. At the same time, the court moved away from the bright-line state law test it had previously announced. The panel focused instead on the ordinary public meaning of “limited partner,” as it existed in 1977 when Section 1402(a)(13) was enacted. The panel described this term as a partner who plays no significant role in managing or running the business.
The panel also rejected the Tax Court’s formulation in Soroban Capital Partners LP v. Commissioner, which treated limited partners as essentially passive investors for purposes of the exclusion. The Fifth Circuit recognized that a limited partner may have some involvement in the business without losing the benefit of the exclusion, provided that the involvement does not amount to a significant role in management, control, or running the business. However, the Second Circuit affirmed the Tax Court’s standard, technically creating a split between the circuits.
Why the Limited Partner Self-Employment Tax Rules Remain Unclear
The revised Fifth Circuit opinion narrows the taxpayer-friendly approach reflected in the withdrawn decision and appears to move closer to the Tax Court’s passive-investor standard, despite claiming to reject it. As a result, the practical difference between the Fifth Circuit’s “no significant role” test and the Tax Court’s “passive-investor” approach remains uncertain. The Second Circuit commented that there is “little daylight” between its passive investor standard and the standard advanced by the Fifth Circuit.
The IRS had argued in its brief for an en banc hearing that it was never its intention, nor the Tax Court’s, to treat the “most minor involvement” in the partnership’s affairs as exceeding limited partner status. The panel’s opinion does not provide detailed guidance on what level of participation is permissible, or where the line should be drawn between nonmanagerial involvement and a significant role in managing or running the business.
The Fifth Circuit’s opinion potentially leaves broader questions unresolved, including how the analysis should apply to partners in other state law entities that are treated as partnerships for federal tax purposes. As such, taxpayers may continue to face inconsistent standards depending on jurisdiction and entity structure.
How Private Equity and Venture Capital Firms Should Approach the Limited Partner Exception After the Ruling
For private equity and venture capital firms, the revised decision reinforces the need to evaluate limited partner self-employment tax positions based on both legal status and actual business involvement. Taxpayers in all jurisdictions must evaluate the Fifth Circuit’s ruling together with a recent decision in the Second Circuit (Soroban), which upheld the Tax Court’s initial ruling, and a pending appeal in the First Circuit (Denham). In the meantime, firms should consider documenting partner roles, governance rights, service arrangements, and compensation structures to support their analysis under the applicable standard.
The Fifth Circuit’s ruling underscores that the limited partner exception remains an unsettled area of law. While the Fifth Circuit rejected a strict passive investor test, it did not provide a clear operational framework for applying Section 1402(a)(13). On the other hand, the Second Circuit affirmed the Tax Court’s passive investor standard, which offers some clues about that framework. Legislative or regulatory guidance may ultimately be needed to provide consistent rules for entities taxed as partnerships.
Talk With CBIZ
If you need help evaluating how these developments may affect your partnership structure or tax position, connect with CBIZ to learn more.
Frequently Asked Questions
The limited partner exception generally excludes certain limited partner distributive shares from self-employment tax, but recent court decisions have conditioned the exception on whether the partner plays a significant role in managing or running the business, or whether the partner is generally akin to a passive investor.
Limited partner self-employment tax rules remain unclear because the language of the statute leaves room for interpretation, and courts have not provided a consistent standard for determining when a partner’s involvement in a partnership exceeds the limited partner exception under Section 1402(a)(13).
Private equity and venture capital firms should review partner roles, governance rights, service arrangements, and compensation structures to assess whether limited partner self-employment tax positions are supportable under current guidance.
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