On January 16, 2026, the Fifth Circuit decided Sirius Solutions, L.L.L.P. v. Commissioner, which vacated a prior decision of the Tax Court that had denied limited partners in a state law limited partnership the benefit of the limited partner exception to self-employment taxes under section 1402(a)(13) of the Internal Revenue Code of 1986, as amended (Code). The Fifth Circuit rejected the Tax Court’s functional test, pursuant to which a partner’s status as a “limited partner” for purposes of the limited partner exception depends on whether the partner is a “passive investor” with respect to the partnership. Instead, relying heavily on the statutory text, the Fifth Circuit concluded that the single best meaning of the term “limited partner” is “a partner in a limited partnership that has limited liability.” Thus, under the definition of "limited partner" adopted by the Fifth Circuit, a partner in a state law limited partnership may benefit from the limited partner exception regardless of the function or role of the partner with respect to the partnership.
Background and Legislative Context
Historically, all partners were subject to self-employment taxes on their respective distributive share of partnership income. In 1977, Congress amended section 1402(a) to exclude from “net earnings from self-employment” the distributive share of partnership income of “a limited partner, as such,” other than guaranteed payments to that partner for services actually rendered as remuneration for such services to or on behalf of the partnership. One of Congress’s stated objectives in amending section 1402 was to exclude “certain earnings which are basically of an investment nature” from the Social Security tax base such that limited partners would not qualify for Social Security benefits on the basis of such income.
Over the years, the courts and IRS in rulings have addressed the limited partner exception. More recently, the IRS has argued the statutory language “limited partner, as such” applies only to limited partners that are mere passive investors in a limited partnership. In 2023, the Tax Court held in Soroban Capital Partners LP v. Commissioner, that a partner’s activities — i.e., his or her “functions and roles” — with respect to a state law limited partnership must be analyzed (the functional test) in order to determine whether the partner qualifies as a “limited partner” for purposes of the limited partner exception. In Sirius, the Fifth Circuit analyzed whether the Tax Court’s functional test is consistent with the Code.
The Case and the Majority Opinion
Sirius Solutions, L.L.L.P. (Sirius) operates a consulting business through a Delaware limited liability limited partnership. For the years at issue, Sirius allocated partnership income to its limited partners and excluded the income from self-employment tax. The IRS disagreed and issued Notices of Final Partnership Administrative Adjustment (FPAAs), reclassifying the distributive shares as net earnings from self-employment.
In 2020, Sirius filed a challenge to the FPAAs in Tax Court, and while the case was pending, the Tax Court issued its decision in Soroban. To facilitate an appeal to the Fifth Circuit, the parties in the Sirius case stipulated that Soroban is controlling as to the Tax Court, and, under the functional test, the partners at issue were not “limited partners, as such” with respect to Sirius. The Tax Court issued a dispositive order which allowed Sirius to appeal the decision (and the underlying functional test) to the Fifth Circuit. The Fifth Circuit in reviewing the Tax Court’s holding in Sirius found no textual basis for reading the functional test into the statute and noted that requiring such a fact-specific test would lead to increased taxpayer uncertainty and inconsistent outcomes — requiring “the help of an army of lawyers and accountants — and a whole lot of luck” to determine if the limited partner exception applies.
The Fifth Circuit held that the “single, best meaning” of the term “limited partner” is “a partner in a limited partnership that has limited liability.”
The court also underscored that Congress has repeatedly demonstrated its ability to tie tax consequences to participation or services when Congress has chosen to do so. According to the court, Congress's decision to not include such criteria in section 1402(a)(13) should, therefore, control.
Finally, the Fifth Circuit explained that whether a partner meets the definition of “limited partner,” section 1402(a)(13) depends on the substantive rights of a person’s interest under state law, and not the label under state law. For example, if a state “labeled someone a ‘schlimited bartner’ under state law, even though they were a member of a limited partnership and had limited liability,” that person would still qualify as a “limited partner” for purposes of section 1402(a)(13).
The Fifth Circuit ultimately held that the Tax Court’s interpretation of the phrase “limited partner,” which requires balancing “an infinite number of factors in performing its ‘functional analysis test,’” under Soroban is “wrong” and “contrary to the [statutory] text.” Accordingly, the Fifth Circuit vacated the Tax Court’s decision and remanded the case for further proceedings.
The Dissent
The decision of the Fifth Circuit was not unanimous, and one judge wrote a dissenting opinion that took a purposive approach, focusing on Congress’s stated intent to exclude only passive income from self-employment taxes. In the dissent’s view, the phrase “limited partner, as such” reflects a functional limitation, restricting the exception to partners acting in a passive, investor-like capacity.
The dissent also expressed concern that modern partnership structures allow individuals to retain limited liability while actively operating businesses, a development the dissent viewed as inconsistent with the assumptions underlying the 1977 amendment. On that basis, the dissent would have upheld the Tax Court’s functional analysis.
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