US Fifth Circuit Confirms Limited Partners Are Not Subject to Self-Employment Tax

Introduction

On 16 January 2026, the United States Court of Appeals for the Fifth Circuit issued a landmark decision in Sirius Solutions, L.L.L.P. v. Commissioner of Internal Revenue, fundamentally rejecting the Internal Revenue Service’s recent approach to self-employment taxation of limited partners. The dispute concerned the interpretation of section 1402(a)(13) of the Internal Revenue Code and whether limited partners who participate in management or operations may nevertheless qualify for the statutory exemption from self-employment tax. The ruling is significant because it directly contradicts the IRS position adopted since 2023 and reverses the US Tax Court’s restrictive “passive investor” interpretation. 24-60240-2026-01-16

Facts of the Case

Sirius Solutions, L.L.P. is a Delaware limited liability partnership operating a business consulting firm in the United States and the United Kingdom. For the tax years 2014 to 2016, Sirius allocated its ordinary business income entirely to its individual limited partners and reported zero net earnings from self-employment, relying on the statutory exclusion applicable to limited partners under section 1402(a)(13). Following an audit, the IRS issued Notices of Final Partnership Administrative Adjustment, concluding that the individual limited partners were not “limited partners” for self-employment tax purposes because they were actively involved in the partnership’s business. On that basis, the IRS recharacterized their distributive shares as net earnings from self-employment subject to Social Security and Medicare taxes. The US Tax Court upheld the adjustments, relying heavily on its prior decision in Soroban Capital Partners, which limited the exemption to passive investors. Sirius appealed to the Fifth Circuit.

Key Legal Findings

The Fifth Circuit squarely rejected the IRS and Tax Court approach. The court held that the term “limited partner” in section 1402(a)(13) refers to a partner who enjoys limited liability under applicable state law, and nothing more. According to the court, the statute’s text does not support importing a functional or activity-based test into the definition, reaching this conclusion, the court relied on three core elements.

First, contemporaneous dictionary definitions at the time of enactment uniformly defined “limited partner” by reference to limited liability, not by the degree of participation in management. Second, the court placed substantial weight on decades of consistent administrative interpretation by both the IRS and the Social Security Administration, which historically treated limited partners as exempt from self-employment tax on distributive shares other than guaranteed payments for services. Third, the court emphasized the statutory structure itself, noting that section 1402(a)(13) explicitly contemplates that limited partners may perform services, since guaranteed payments for such services are expressly carved out and taxed. The court concluded that the IRS’s recent “passive investor” test was unsupported by statutory text, administratively inconsistent, and created unacceptable uncertainty for taxpayers. The Tax Court’s decision was therefore vacated and remanded.

Analytical Commentary

From a doctrinal perspective, the decision marks a decisive reaffirmation of textual statutory interpretation in federal tax law. The Fifth Circuit rejected a policy-driven or purposive narrowing of the statute in favor of its ordinary meaning at enactment, reinforced by long standing administrative guidance. This approach significantly undermines the IRS’s litigation strategy developed in Soroban and Denham, which sought to recharacterize active limited partners as self-employed individuals based on functional involvement.

Practically, the ruling restores predictability for partnerships structured under state limited partnership laws. By anchoring the analysis to limited liability rather than subjective assessments of activity, the court eliminated the need for complex, fact-intensive inquiries into management functions. This is particularly relevant for professional services, investment, and consulting partnerships where limited partners often play operational roles without assuming unlimited liability. Although the decision is formally binding only within the Fifth Circuit, its reasoning is likely to influence other appellate courts given its detailed treatment of statutory text and administrative practice. At the same time, the IRS has indicated that it maintains a contrary view and may continue to challenge refund claims outside the circuit, increasing the likelihood of a future Supreme Court review.

Strategic Insight

In the short term, partnerships with limited partners operating in Texas, Louisiana, and Mississippi should reassess their self-employment tax positions, particularly where prior adjustments were driven by the IRS’s passive investor theory. Protective refund claims may be advisable where assessments were paid under protest. More broadly, the decision strengthens the case for structuring partner participation through state-law limited partnership frameworks where limited liability is clearly preserved. However, caution remains essential. The ruling does not eliminate self-employment tax exposure on guaranteed payments for services, nor does it resolve how similar principles apply to members of LLCs or LLPs in other circuits. Given the IRS’s stated intent to pursue conflicting outcomes elsewhere, taxpayers should expect continued controversy and uneven enforcement in the near term.

How Can MCORE Help

MCORE Law advises partnerships, fund managers, and professional firms on self employment tax exposure, partnership structuring, and controversy management. We assist clients in evaluating the impact of the Sirius decision, preparing protective refund claims, defending audits, and designing governance and compensation structures aligned with current case law while anticipating future litigation risk.