In Sirius Solutions v. Commissioner, No. 24-60240 (5th Cir. January 16, 2026), the United States Court of Appeals for the Fifth Circuit rejected the Tax Court's interpretation of the term "limited partner" in IRC Section 1402(a)(13), which would have made limited partners in a consulting firm liable for self-employment tax on their distributive share of the firm's business income.

Facts

Sirius Solutions LLLP (Sirius), a limited liability limited partnership, operates a business consulting firm with offices in Houston, Dallas and London. For tax years 2014 through 2016, Sirius reported ordinary income from its consulting business and allocated that income to its limited partners. For employment tax purposes, the firm reported no net earnings from self-employment (NESE) on the grounds that the income was excluded from NESE under the limited partner exception in IRC Section 1402(a)(13).

On auditing Sirius's returns for 2014 through 2016, the IRS determined that none of Sirius's limited partners qualified as "limited partners" under the exception. As such, the distributed income qualified as NESE on which self-employment tax was owed.

Sirius petitioned the Tax Court, which agreed with the IRS. Citing Soroban Capital Partners LP vs. Commissioner, 161 T.C. 310, the Tax Court held that the limited partner exception only applies to limited partners that are passive investors.

Law and analysis

IRC Section 1402(a) defines NESE to include:

the gross income derived by an individual from any trade or business carried on by such individual, less the deductions allowed by [subtitle A] which are attributable to such trade or business, plus his distributive share (whether or not distributed) of income or loss described in IRC Section 702(a)(8) from any trade or business carried on by a partnership of which he is a member … .

The limited partner exception in IRC Section 1402(a)(13) excludes from NESE:

[the] distributive share of any item of income or loss of a limited partner, as such, other than guaranteed payments described in IRC Section 707(c) 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 of those services …

In Soroban Capital Partners LP v. Commissioner, 161 T.C. 310 (2023), the Tax Court held that it had jurisdiction to determine a state law limited partner's status for the purpose of applying the limited partner exception in partnership-level proceedings, and that the determinations require a functional analysis inquiry to determine the roles and responsibilities of partners to determine their tax status. The Tax Court further applied this functional analysis test in Denham Capital Management LP, T.C. Memo. 2024-114 (2024) and Soroban Capital Partners LP, T.C. Memo 2025-52 (2025). Taxpayers in both cases have appealed the Tax Court's rulings to the Second and First Circuit Courts of Appeals, respectively.

Rejecting the Tax Court's analysis in Denham and Sorobon, the Fifth Circuit held that a "limited partner" for purposes of the Iimited partner exception means a limited partner in a state-law limited partnership that is afforded limited liability. In defining a limited partner according to state-law constructs, the Fifth Circuit focused on the text of the statute and the IRS's and Social Security Administration's contemporaneous interpretations of the term. The Fifth Circuit explicitly rejected both the IRS's "passive investor" rule and the "functional analysis" test previously adopted by the Tax Court. It then vacated the Tax Court's decision and remanded for further proceedings.

The Fifth Circuit noted, however, that the government failed in its appeal to raise the Tax Court's argument about a "limited partner, as such," which addressed the existence of dual-status arrangements where a limited partner could have "multiple functions or capacities."

In a lengthy dissenting opinion, Judge Graves agreed with the Tax Court that the limited partner exception applied only to passive investors and should not apply in this case, based on the limited partners' management and control of the firm.

Implications

While this is a welcome ruling for many taxpayers facing similar inquiries, the issue is far from settled. The government has 45 days to request a rehearing. On remand, the Tax Court could still find that the limited partners at issue participated to such a degree in the partnership that they held "multiple functions or capacities."

Additionally, other cases are awaiting hearings and decisions in the First and Second Circuits, where the government could pull from the dissenting opinion in Sirius in reiterating its position. Several taxpayers are currently awaiting trial in the Tax Court. Even if the Tax Court holds that the "limited partner exception" in IRC 1402(a)(13) applies in Sirius, the Tax Court may stick by its "functional analysis" / "passive investor" reasoning for taxpayers whose appeal lies outside the Fifth Circuit.