Everything You Need to Know About Sirus in 2024

A Texas consulting firm is urging the Fifth Circuit to reverse the Tax Court’s Soroban ruling by holding that the limited partner exception to self-employment tax is intended to apply to state law limited partners.

The Tax Court erred by interpreting the term “limited partner” in section 1402(a) (13) to mean a partner functioning as a passive investor, Sirius Solutions LLLP asserted in its Aug. 12 opening brief in Sirius Solutions LLLP v. Commissioner.

“Dictionary definitions and contemporaneous and long-held guidance from the IRS and Social Security Administration all confirm that the ordinary meaning of the term ‘limited partner’ is a state-law limited partner,” the firm’s brief argues.

Sirius, a Delaware limited liability limited partnership that operates a business consulting firm based in Houston, is appealing the Tax Court’s application of Soroban Capital Partners LP v. Commissioner, 161 T.C. No. 12 (2023) to its own dispute with the IRS regarding the scope of section 1402(a) (13).

The provision, enacted in 1977, excludes from the calculation of net self-employment earnings subject to Self-Employment Contributions Act (SECA) tax the distributive share of income or loss of a “limited partner, as such.” The exclusion doesn’t apply to guaranteed payments that a limited partner receives for services rendered to the partnership.

Because the statute doesn’t define a limited partner, the scope of the exemption has been the subject of a long-standing dispute between the IRS and taxpayers. According to the IRS, the SECA exclusion in section 1402(a) (13) applies only to passive investors. It contends that limited partner status doesn’t hinge on state law classifications and that a functional analysis is required to determine who qualifies as a limited partner for SECA purposes.

Sirius is one of several taxpayers organized as state law limited partnerships that have filed Tax Court petitions challenging the IRS’s position. They contend that the term “limited partner” means an individual admitted as a limited partner under state law. That interpretation would be consistent with the term’s ordinary meaning at the time the statute was enacted, they argue.

In its November 2023 precedential opinion in Soroban — a case brought by a New York hedge fund organized as a Delaware limited partnership — the Tax Court addressed for the first time how section 1402(a) (13) applies to “active” limited partners of state law limited partnerships. Agreeing with the IRS, the Tax Court in Soroban held that state law classifications aren’t controlling and that a functional analysis is required to determine whether a partner in a state law limited partnership is a limited partner for purposes of section 1402(a) (13).

Because its Tax Court case was at a more advanced stage of litigation than those in Soroban and other pending SECA tax disputes, Sirius decided to settle with the IRS so it could appeal the Soroban holding to the Fifth Circuit. Under a stipulation filed with the Tax Court in December 2023, Sirius and the IRS agreed that the Soroban opinion applied to the determination of Sirius’s tax liability for tax years 2014 through 2016.

With Sirius getting the first shot at appellate review of Soroban, the firm’s appeal is expected to be closely followed by the tax community.

Flawed Statutory Analysis

The Tax Court in Soroban erroneously resorted to legislative history when the statute is unambiguous, Sirius asserts in its opening brief.

The firm’s position that a limited partner is a state law limited partner is “consistent with its ordinary and long-recognized meaning,” the brief says, adding that undefined statutory terms must be given their ordinary meaning at the time of enactment.

“The ordinary meaning of the term ‘limited partner’ in 1977 under dictionary definitions and contemporaneous interpretations by the IRS and Social Security Administration is a partner with limited liability — commonly understood as a state-law limited partner, as confirmed by a later directive from Congress,” the brief says.

Sirius asserts that for nearly 50 years after the 1977 enactment of section 1402(a) (13), the IRS issued contemporaneous guidance defining a limited partner as a partner with limited liability – in other words, as a state law limited partner. That guidance included instructions to the Form 1065, “U.S. Return of Partnership Income,” and to Schedule SE, “Self-Employment Tax,” the brief says.

Sirius noted that in the Supreme Court’s June 28 majority opinion in Loper Bright Enterprises Inc. v. Raimondo, No. 22-451 (S. Ct. 2024), the Court said that an agency’s interpretation of a statutory term that was issued contemporaneously with the statute at issue, and that has remained consistent over time, is “especially useful” in determining the statute’s meaning.

The brief also pointed to regulations issued in 1980 by the Social Security Administration implementing conforming changes made to the Social Security earnings base by the 1977 enactment of section 1402(a) (13). Like the IRS’s instructions to various tax forms, the regs defined limited partners as state law limited partners, Sirius says, adding that “the exception to self-employment taxes and the corresponding exception from Social Security eligibility must be construed together.”

The IRS and Treasury’s repeated statements that a limited partner is a state law limited partner “are diametrically opposed to the IRS’s litigating position, making it difficult for taxpayers to even know about, let alone comply with, the IRS’s interpretation of the term ‘limited partner’ in this case,” the brief argues, adding that the Fifth Circuit “should reject the IRS’s attempt to now disavow its guidance of almost 50 years.”

1997 Moratorium

Congress’s negative response to proposed SECA regs (REG-209824-96) that Treasury and the IRS issued in 1997 — which would have required functional tests for determining SECA limited partner status — indicates that lawmakers disagreed with the government’s position, according to Sirius.

The firm notes that Congress in 1997 imposed a one-year moratorium on the regs’ finalization, citing concerns that “the proposed change in the treatment of individuals who are limited partners under applicable State law exceeds the regulatory authority of” Treasury and would “effectively change the law administratively without congressional action.”

Treasury and the IRS shelved the guidance project after the moratorium expired and Congress made no statutory amendments to section 1402(a) (13) in the ensuing years.

The 1997 moratorium “made clear Congress’s view that ‘limited partner’ for purposes of section 1402(a) (13) means a state-law limited partner, and Congress had not conferred ‘authority’ on the Treasury Department or IRS to decide otherwise,” Sirius argues.

The firm further contends that the Tax Court in Soroban misinterpreted the phrase “a limited partner, as such” as reflecting congressional intent that the SECA tax exclusion applies only to partners that function as passive investors.

“The ‘as such’ language was necessary because in 1977, as today, the same person could be both a general partner and a limited partner of a partnership,” the brief says.

“Congress appreciated that a particular partner could wear two hats — general partner and limited partner — with respect to the same partnership and distinguished between them with the inclusion of the phrase ‘as such,’” Sirius asserts.

Because Congress excluded the distributive share received as a limited partner but not the distributive share of that same partner received as a general partner, the statute would be ambiguous if the “as such” wasn’t included as to whether a limited partner’s distributive share would be exempt if that partner was also a general partner, the brief says.

The Tax Court’s interpretation “violates a canon of statutory interpretation by rendering the carve-out for ‘guaranteed payments’ meaningless,” the brief added.

The appellant in Sirius Solutions LLLP v. Commissioner, No. 24-60240 (5th Cir.), is represented by Mary A. McNulty, Lee S. Meyercord, Meghan McCaig, and Rich Phillips of Holland & Knight LLP.