Fifth Circuit Reverses Course On Limited Partner Self-Employment Tax Exception

In a move that shocked galore taxation practitioners, the Fifth Circuit has withdrawn its January sentiment successful a intimately watched business taxation case. In its spot is simply a importantly different mentation of who qualifies arsenic a “limited partner” for purposes of the self-employment taxation exception.

Background and Procedure

In January, the U.S. Court of Appeals for the Fifth Circuit held successful Sirius Solutions, L.L.L.P. v. Commissioner that the word “limited partner” nether conception 1402(a)(13) of the taxation codification meant a state-law constricted partner pinch constricted liability. Under that approach, what a partner really did for the business did not find whether the objection applied—that was a very different return from the IRS’s view.

On August 12, 2026, the tribunal withdrew its January sentiment successful its entirety and issued a substitute sentiment successful the lawsuit (now captioned K Alain L.L.L.P. v. Commissioner). The tribunal now holds that a constricted partner for purposes of conception 1402(a)(13) is simply a partner who plays “no important domiciled successful managing aliases moving a business.”

If the full point has you scratching your head, it’s because this is not what happens successful astir tribunal cases. Procedurally, here’s what happened.

After that January ruling, the authorities asked for an en banc rehearing. That intends it asked the Fifth Circuit to reconsider the January decision. En banc rehearing requires action by the eligible progressive judges of the circuit and is considered extraordinary.

The Fifth Circuit denied the request. But the original three-judge sheet treated the en banc petition arsenic besides asking for sheet rehearing. A sheet rehearing asks the original three-judge appellate sheet to reconsider its ain determination because it allegedly overlooked aliases misapprehended a worldly constituent of rule aliases fact.

Ordinarily, the Fifth Circuit requires abstracted petitions for sheet and en banc rehearing. But here, the original sheet granted rehearing, meaning that the judges who decided Sirius successful January agreed to reconsider their ain decision. On reconsideration, the sheet withdrew the original sentiment and substituted a caller one.

It besides vacated the Tax Court's determination and remanded for the Tax Court to find whether the partners fulfill the caller standard. That intends that the Tax Court now has activity to do.

The Tax Bits

Here’s what’s astatine stake. Generally, a partner's stock of business waste and acquisition aliases business income is included successful nett net from self-employment and taxable to self-employment tax. But there’s an objection for “the distributive stock of immoderate point of income aliases nonaccomplishment of a constricted partner, arsenic such,” different than definite guaranteed payments for services nether conception 707(c).

For years, taxpayers and the IRS person disagreed complete what Congress meant by a constricted partner. The IRS has mostly based on that the objection should not shelter net attributable to a partner’s services. The Tax Court adopted a type of that attack successful a lawsuit presently pending successful different circuit. In Soroban Capital Partners LP v. Commissioner, 161 T.C. 310 (2023), the tribunal concluded that determining whether personification is simply a “limited partner, arsenic such” requires looking beyond state-law position and considering whether the partner is functioning arsenic a passive investor.

However, the Fifth Circuit rejected that attack successful its original January opinion. There, the tribunal treated a constricted partner mostly arsenic a ineligible status. If a personification was a partner successful a state-law constricted business and enjoyed constricted liability, the tribunal concluded, that personification was a constricted partner for purposes of conception 1402(a)(13).

That produced a comparatively straightforward rule: constricted liability, alternatively than information successful the business, controlled. The substitute sentiment takes a different approach.

The New Opinion

In the caller opinion, the Court held that the meaning of constricted partner nether conception 1402(a)(13) is “a partner who plays nary important domiciled successful managing aliases moving a business.” The caller sentiment does not supply overmuch guidance for determining erstwhile a guidance domiciled becomes “significant,” alternatively leaving the Tax Court to use the caller trial connected remand.

The tribunal still rejects the Tax Court’s “functional analysis” from Soroban, which focused connected whether a partner was functioning arsenic a passive investor. But the Fifth Circuit has besides abandoned the bright-line limited-liability norm it adopted successful January.

The Fifth Circuit focused connected what the word “limited partner” would person meant erstwhile Congress enacted conception 1402(a)(13) successful 1977. Looking to modern ineligible dictionaries, business statutes, and treatises, the tribunal concluded that the word historically described a partner who did not play a important domiciled successful managing aliases moving the partnership. That intends constricted liability, opinionated alone, is nary longer enough.

But neither, according to the Fifth Circuit, is the Tax Court’s passive-investor test.

So, the caller sentiment does not connection a bright-line rule. Instead, the consequence looks overmuch much for illustration the benignant of facts-and-circumstances enquiry acquainted passim taxation law. That intends facts base connected a partner's domiciled successful managing aliases moving the business whitethorn now matter. Simply providing services, however, does not needfully reply the question—the tribunal expressly rejected a norm that equates constricted partner position pinch axenic passivity.

What About Partners Wearing Two Hats?

The caller modular besides raises questions for partners who enactment successful much than 1 capacity. A partner, for example, mightiness clasp some a wide partner liking and a constricted partner interest, participating successful guidance done the erstwhile while receiving a distributive stock done the latter. Section 1402(a)(13) excludes the distributive stock of a “limited partner, arsenic such,” and the Fifth Circuit does not explicate really its caller management-based trial applies erstwhile the aforesaid personification wears some hats.

Does important guidance activity successful 1 capacity forestall the objection from applying to income received successful another? Or does the statutory building “as such” require those interests to beryllium considered separately? For dual-capacity partners, that remains an unfastened question.

What Happens Next?

A Fifth Circuit determination is binding precedent for national courts wrong that circuit, which includes Louisiana, Mississippi, and Texas. Elsewhere, the broader conflict complete conception 1402(a)(13) remains unsettled.

In the First Circuit, Denham Capital Management LP v. Commissioner, was based on connected February 5, 2026. That tribunal has since requested supplemental briefing connected a jurisdictional issue, which could let it to dispose of the entreaty without reaching the conception 1402(a)(13) question.

In the Second Circuit, Soroban was based on connected June 25, 2026. (The Fifth Circuit made clear that it disagrees pinch the underlying issues successful Soroban.)

If different circuit adopts the Tax Court’s passive-investor approach—or different reaches a consequence inconsistent pinch the Fifth Circuit—a travel to the Supreme Court is not retired of the question.

For taxpayers, meanwhile, the takeaway from the Fifth Circuit is nary longer the elemental norm announced successful January. Limited liability unsocial is not enough. But information successful the business does not automatically disqualify a partner, either. The mobility now is whether the partner plays a important domiciled successful managing aliases moving the business.