Fifth Circuit Rules that All Limited Partners Having Limited Liability are Exempt from Self-Employment Tax Even If They Participate in Management

In a recent decision of great interest to investment fund management companies organized as limited partnerships (LPs), the Court of Appeals for the Fifth Circuit held that a limited partner in a state-law LP is not subject to self-employment tax so long as the limited partner has limited liability, even if the limited partner participates in the management of the partnership and is involved in the partnership’s provision of management services. Sirius Solutions, L.L.L.P v. Commissioner, No. 24-60240 (5th Cir. Jan. 16, 2026).

The “Limited Partner” Exclusion from Self-Employment Tax

By way of background, self-employed individuals, generally including partners in partnerships that are engaged in a trade or business, are subject to the self-employment tax. The self-employment tax is the equivalent of both the employer’s share and the employee’s share of the social security and Medicare taxes in the employment context, currently amounting to 2.9% of the individual’s “net earnings from self-employment” (uncapped) plus 12.4% of those earnings up to the social security wage cap (which is $184,500 for 2026). The statute, however, generally excludes from the definition of “net earnings from self-employment” the distributive share of a “limited partner, as such.” Congress’s purpose in enacting this limited partner exclusion was to prevent mere investors in partnerships who did not actively participate in the partnership’s business operations from receiving credits toward Social Security benefits.          

Are State-Law Limited Partners “Limited Partners” for this Purpose?

The limited partners of investment fund management companies that are organized as LPs often have limited liability under the applicable LP law but are involved in the partnership’s provision of management services to the underlying investment funds. It is a question of great significance to these limited partners whether their status as state-law limited partners means that they are per se considered “limited partners” for purposes of the exclusion from self-employment tax.

The Tax Court says not necessarily. In 2023, in a precedential opinion (Soroban Capital Partners LP v. Commissioner, 161 T.C. 310 (2023)) involving a state-law LP operating as a hedge fund manager, the Tax Court rejected the taxpayer’s argument that a state-law limited partner is per se a “limited partner” for purposes of the exclusion and held that the “functional analysis” test that the Tax Court had previously applied to members of LLCs and LLPs (a test that looks not only to limited liability but also to factors such as the extent to which the partner participates in management) applies even to a state-law limited partner. The court’s rationale for this conclusion revolved around Congress’s use of the term “limited partner, as such” rather than “limited partner.” Commentators have noted that this reading of the statutory language is questionable and that a more natural reading, and one that is arguably supported by the legislative history, is that the exclusion applies to an individual’s interest as a limited partner having limited liability even where the individual is also a general partner and in that capacity participates in management. Also relevant here is a moratorium that Congress enacted in 1997 on the promulgation of regulations on the subject due to a concern on the part of Congress that the Treasury Department does not have authority to determine that a state-law limited partner is not a “limited partner” within the meaning of the statute.

The Tax Court subsequently applied the functional analysis test to state-law limited partners in two 2024 non-precedential decisions (Sirius Solutions, L.L.L.P v. Commissioner and Denham Capital Management LP v. Commissioner) and in further proceedings in Soroban Capital in 2025, which cases together establish a rule in the Tax Court that a state-law limited partner is not considered a “limited partner, as such” if, for example, the income of the partnership consists of fees for management services, the limited partner’s time, skills and judgment are essential to the provision of these services and the limited partner devotes substantially all of his or her time to, and participates in the management of, the partnership. The taxpayers in Soroban Capital, Sirius Solutions and Denham Capital all appealed their cases to their respective Courts of Appeals.

The Fifth Circuit says yes. In Sirius Solutions, the first of these appeals to be decided, the Court of Appeals for the Fifth Circuit, in a 2-1 decision issued on January 16, 2026, reversed the Tax Court and held that a state-law limited partner who has limited liability is a “limited partner, as such” for purposes of the self-employment tax irrespective of the extent to which the partner participates in management. The majority grounded its decision on what it determined to be the plain meaning of the statutory term, based on dictionary definitions of the term “limited partner” at the time the limited partner exclusion was first enacted in 1977 and guidance issued by the IRS and the Social Security Administration interpreting the limited partner exclusion. Rejecting the Tax Court’s contrary interpretation, the majority held that the “as such” language in the statute was designed not to require the application of a functional analysis test to state-law limited partners but rather to address situations where a limited partner is also a general partner by limiting the exclusion to the partner’s interest as a limited partner. The majority declined to consider the legislative history that the government cited on the ground that legislative history is generally of dubious value in statutory interpretation, and is not to be consulted where the text of the statute has a clear meaning, and in any event found the legislative history not to support the government’s position.   

The dissenting judge in Sirius Solutions argued that the majority cherry-picked the dictionary definitions of “limited partner” that it relied on, ignoring other parts of the definitions that support the government’s position, read the words “as such” out of the statute, misinterpreted the IRS guidance and failed to give due regard to relevant legislative history that supports the government’s position. 

Observations

The issue raised in these cases would not have arisen under traditional LP statutes, which required as a condition of status as a limited partner a very limited role in management. Now that state LP statutes allow limited partners to be involved in management without losing their limited liability, it becomes necessary to determine which traditional badge of limited partner status — limited liability, limited participation in management or both — determines whether a partner is a “limited parter, as such” for purposes of the exclusion from the self-employment tax. The decision in Sirius Solutions bolsters the position that limited partners in investment fund management companies organized as LPs have long taken based on the language of the statute that their status as limited partners with limited liability under state law is sufficient to exclude their distributive shares from the self-employment tax. It should be noted that where an investment fund management company is structured as an LLC rather than as an LP, different considerations may apply and it is not expected that the decision in Sirius Solutions will provide much support for the position that the LLC’s members are eligible for the exclusion. For newly formed management companies, consideration should be given to forming them as LPs rather than LLCs.

The decision in Sirius Solutions is directly precedential only in the Fifth Circuit (that is, for limited partners located in Texas, Mississippi and Louisiana). It remains to be seen whether other Courts of Appeals that consider the issue, in Soroban Capital, Denham Capital or otherwise, will come to the same conclusion as the Fifth Circuit in Sirius Solutions and, if not, whether the Supreme Court will take the case and have the last word on the subject. Another possibility, albeit unlikely in the current political climate, is that Congress will step in and amend the statute to clarify the issue one way or the other. Given the current state of play, limited partners in investment fund management companies organized as LPs would be well advised to defer their celebrations and stay tuned.

Co-authors Mark Berg, chair, and Sarah Herman, of counsel, are members of the tax practice group at Klehr Harrison.