Fifth Circuit Reverses Tax Court on Limited Partner Self-Employment Tax in Sirius Solutions
On January 16, 2026, the U.S. Court of Appeals for the Fifth Circuit ruled in Sirius Solutions, L.L.L.P. v. Commissioner that a state-law limited partner with limited liability qualifies for the 15.3% self-employment tax exception, reversing the Tax Court’s contrary holding in Soroban Capital Partners seven months earlier. The decision creates a circuit split that primarily affects active fund principals and managers who hold limited partner units in their own management entity, in hedge funds, private equity, and venture partnerships. Passive U.S. investors who contributed capital and do not work for the fund remain outside the SE tax net regardless of circuit.
What Just Changed
The Fifth Circuit’s Sirius Solutions decision rejected the activity-based “functional analysis” that the Tax Court built in Soroban. The 2-1 majority held that the limited partner exception in Internal Revenue Code Section 1402(a)(13) applies to a state-law limited partner who has limited liability, without any further inquiry into what that partner does day to day.
In plain English: if your partnership agreement and state law say you are a limited partner, the Fifth Circuit will not let the IRS look behind the curtain. That is a meaningful taxpayer win, and a direct rebuke of the position the IRS has been pushing in Soroban and follow-on cases. For a fund principal earning $1 million in distributive income, the SECA gap is roughly $28,000 a year, depending on structure and the 2026 Social Security wage base. The dollars are real.
The Tax Court’s Position in Soroban
The original Soroban Capital Partners LP v. Commissioner decision came down on May 28, 2025, as T.C. Memo. 2025-52. The Tax Court held that three Soroban hedge fund partners labeled “limited partners” on paper were not limited partners “as such” for purposes of Section 1402(a)(13).
The court applied a functional analysis that asked what those partners actually did day to day. It found they worked full time managing the fund, oversaw daily operations, were essential to the firm’s services, were held out to the public as essential, and contributed insignificant capital relative to the fees they earned. Because they functioned as active managers rather than passive investors, the Tax Court ruled their distributive shares of partnership income were subject to self-employment tax.
The Tax Court has reaffirmed that approach in subsequent cases. Inside the Tax Court, the functional test is the operative law.
How the Two Standards Compare
| Court | Test for the limited partner exception | What the IRS examines |
|---|---|---|
| Tax Court (Soroban) | Functional analysis of activity | Day-to-day role, hours worked, capital contributions, public-facing positioning |
| Fifth Circuit (Sirius Solutions) | State-law limited partner status with limited liability | The partnership agreement and state law alone |
For a U.S. investor in a fund formed in or litigated within the Fifth Circuit (Texas, Louisiana, Mississippi), the Sirius standard applies. For everyone else, the Tax Court’s functional test is the prevailing approach unless and until another circuit weighs in.
What’s Coming Next
Two more appellate decisions are expected to land in 2026.
- Soroban Capital Partners itself is on appeal at the Second Circuit, with a decision expected later this year. If the Second Circuit affirms, the IRS position holds in New York, Connecticut, and Vermont. If it follows the Fifth Circuit, the split widens, and the IRS position weakens significantly.
- Denham Capital Management is pending at the First Circuit, also expected in 2026.
A meaningful split between circuits is the standard predicate for Supreme Court review. If the IRS loses at the Second Circuit, expect a petition.
Who This Affects
The litigation is most relevant to two reader groups.
- Active fund principals and managers holding limited partner units in their own management entity, especially those drawing meaningful guaranteed payments or distributive shares of fee income. The 15.3% question lands directly on this group.
- U.S. expats and dual residents with stakes in foreign hedge funds, private equity partnerships, or venture funds that include a U.S. limited partnership tier. The foreign character of the underlying fund does not, in itself, change the SECA analysis. The U.S.-side feeder is where the rule applies.
Passive U.S. investors who do not work for the fund are largely outside the dispute, regardless of circuit.
U.S. Expat With a Stake in a Foreign Fund? The SECA Analysis Hits the U.S. Tier.
What Active Limited Partners Need to Know
If you are a fund principal, a managing member who took limited partner status for liability reasons, or a partner who works full-time at the partnership, the picture is genuinely uncertain in 2026.
- Inside the Tax Court, the Soroban functional test is the law. A return that excludes your distributive share from self-employment tax may invite a challenge.
- Inside the Fifth Circuit, the Sirius Solutions state-law approach controls. State-law limited partner status with limited liability fits the exception.
- Everywhere else, the Tax Court’s reasoning is persuasive but not binding precedent on the federal courts of appeals. The Second Circuit’s coming Soroban decision will shape the analysis for taxpayers in New York, Connecticut, and Vermont.
The right answer depends on the partnership agreement, the state of formation, the relevant circuit, and the partner’s actual role. This is a coordinate-with-counsel question, not a self-serve question.
What You Should Do Now
- If you are a passive U.S. investor in a foreign fund, confirm with your fund manager that your interest is structured as a passive limited-partner stake, and retain documentation of capital contributions and the absence of any management role. Most passive investors will continue filing as they did before.
- If you are a fund principal or active limited partner in the Fifth Circuit, the Sirius Solutions opinion may support an exclusion from SECA. Coordinate with counsel before relying on it, and watch for any IRS petition for rehearing or Supreme Court review.
- If you are a fund principal or active limited partner outside the Fifth Circuit, the Tax Court’s functional analysis still applies in your circuit. Filing decisions made before the Second Circuit and First Circuit rulings should be made conservatively, with appropriate reserves.
- If you are a U.S. expat with a stake in a foreign-domiciled fund, look at how the U.S. tier of your investment is structured. Most foreign hedge funds and private equity vehicles have a U.S.-side feeder or general partner, which is where the SECA analysis lands.
- If the IRS has already opened an examination on this issue, stop filing or amending without representation. Soroban-related audits are now multi-year, multi-document matters.
A cross-border tax adviser who works with fund principals and limited partners every day can read your structure against the right circuit standard and tell you which filing position you can defend.
Ready to Get Your Partnership Filing Right in a Shifting Landscape?
Frequently Asked Questions
It depends on what you do for the partnership and where you are located. If you are a passive investor who contributed capital and do not work for the fund, the answer is almost always no, regardless of circuit. If you work full-time managing the fund and hold limited partner status for liability reasons, the answer depends on your circuit. The Fifth Circuit says no in Sirius Solutions. The Tax Court says yes under Soroban. Other circuits have not yet ruled.
Internal Revenue Code Section 1402(a)(13) excludes a limited partner’s distributive share of partnership income from net earnings from self-employment, unless that share consists of guaranteed payments for services. The exception was written in 1977, before modern LLPs and LLLPs existed, which is why the courts are still arguing about who counts as a “limited partner.”
No, not as binding precedent. The Tax Court’s Soroban approach applies nationwide in U.S. Tax Court cases, and the federal courts of appeals outside the Fifth Circuit have not adopted Sirius Solutions. The opinion is still persuasive authority, and tax advisers in other circuits may cite it, but it is not binding outside the Fifth Circuit.
The combined SECA tax rate is 15.3% on net earnings from self-employment up to the Social Security wage base, made up of 12.4% for Social Security and 2.9% for Medicare. An additional 0.9% Medicare surtax applies to high earners. Above the Social Security wage base, only the Medicare portion (and surtax) continues to apply.
It might. A meaningful split between circuits is the standard predicate for Supreme Court review. The Second Circuit’s upcoming decision in Soroban and the First Circuit’s upcoming decision in Denham Capital Management will determine whether the IRS files a petition. Expect movement in late 2026 or 2027 if the split holds.
Subscription documents showing your initial capital contribution, your partnership agreement showing your limited partner status, K-1s from each year, and any communication confirming you do not provide management services. Funds where the same individuals serve as both managers and “limited partners” are most at risk, so a clear paper trail matters.
A decision is expected later in 2026. Briefing concluded earlier in the year. The Second Circuit’s ruling will be the most consequential development in this area for the rest of the year, and may prompt the IRS to seek Supreme Court review if it loses.
The information in this article is for general informational purposes only and does not constitute tax, legal, or financial advice. Tax rules are complex and change frequently. Consult a qualified tax professional regarding your specific situation before taking any action.
