On January 16, 2026, the United States Court of Appeals for the Fifth Circuit issued a ruling defining the term “limited partner” as used in the Internal Revenue Code of 1986, as amended[1] (the “Code”). The Court held that a “limited partner” is any partner that, under state limited partnership law, has limited liability status.[2] In reaching this decision, the Fifth Circuit overturned the United States Tax Court (the “Tax Court”) ruling, rejecting the previous and more narrow approach of excepting only partners that are “passive investors” in a limited partnership.[3] The decision enables limited partners to qualify for an exception from self-employment tax for “the distributive share of any item of income or loss of a limited partner, as such,” under Section 1402(a)(13) of the Code (the “Exception”) without inquiry into the management roles and responsibilities of the limited partners.
Background
The Code imposes self-employment tax on net earnings from self-employment, which includes income derived from the active conduct of a trade or business.[4] Generally, a partner’s distributive share of partnership income is subject to self-employment tax, unless an exception applies.[5]
Sirius Solutions, L.L.L.P. (“Sirius”), a limited liability limited partnership formed under Delaware state law, operates a business consulting firm based in Houston, Texas. The case arose following IRS audits of Sirius’s partnership income allocations. For the 2014–2016 tax years, Sirius reported no self‑employment earnings, asserting that its limited partners qualified for the Exception. The IRS disagreed, determining that the partners’ roles did not align with the statutory definition of “limited partner,” and issued adjustments totaling several million dollars in self‑employment tax. Sirius appealed the IRS determination to the Tax Court. The Tax Court sided with the IRS following its precedent that the term “limited partners” only refers to passive investors.[6]
Decision
On appeal, the Fifth Circuit rejected the Tax Court’s conventional “passive investor” standard and held that a partner in a limited partnership qualifies as a “limited partner” for purposes of the Exception if the partner has limited liability. Since the Code does not define what constitutes a “limited partner” for purposes of the Exception at issue, the Fifth Circuit closely examined statutory text, historical interpretations by the IRS and Social Security Administration, and dictionary definitions from when the Exception was enacted. The Fifth Circuit concluded that a “limited partner” is most appropriately defined by the partner’s limited liability status.
The Fifth Circuit’s bright line rule considers only a partner’s limited liability status under state law to qualify for the Exception. Accordingly, the Fifth Circuit ruling dispenses of the need for a fact-intensive inquiry into the roles and responsibilities of a given partner to determine Exception eligibility.
Analysis and Impact
The Fifth Circuit’s opinion is a practical victory for taxpayers. The decision enables limited partners to rely on their status under state corporate law for the Exception. This result leaves the IRS with little room for contrary arguments and promotes greater predictability and consistency in partnership tax treatment.
Notably, the Fifth Circuit’s decision did not limit its reasoning to any particular enterprise. Therefore, the Fifth Circuit’s reasoning would likely apply to other types of businesses, such as investment funds, which are often organized as limited partnerships under state law. Given the Fifth Circuit’s opinion, entities taxed as partnerships that have not previously utilized the Exception may wish to evaluate whether protective filings are appropriate to safeguard any potential refund opportunities.
Rhode Island and other jurisdictions in New England have enacted limited partnership statutes.[7] Using Rhode Island as an example, under the Uniform Limited Partnership Act, one becomes a limited partner as agreed among the initial partners upon formation of the limited partnership, or through several post-formation methods, including as provided in the partnership agreement.[8] Limited partners in Rhode Island limited partnerships receive explicit statutory limited liability protection.[9] Accordingly, limited partners in Rhode Island limited partnerships should qualify as “limited partners” for purposes of the Exception under the Fifth Circuit’s ruling.
Sirius Solutions is one of several cases in which the Tax Court adopted the government-friendly passive investor standard, and the Fifth Circuit’s rejection of the Tax Court’s approach is the first decision from a United States Court of Appeals on this issue. A similar case concerning the Exception has been appealed from the Tax Court to the United States Court of Appeals for the First Circuit.[10] If the First Circuit reaches a different conclusion, creating a circuit split, the United States Supreme Court may grant certiorari, given the issue’s potential impact on federal revenues, its close connection to interstate commerce, and the natural intersection it presents between federal and state law. In the interim, outside the Fifth Circuit’s jurisdiction, partners that claim the Exception while materially participating in limited partnership business management and affairs may continue to face IRS challenges.
Readers are encouraged to contact Kristen Alberione or Matthew Bertelli at kalberione@apslaw.com or mbertelli@apslaw.com, respectively, for more information about Sirius Solutions, the Exception, and the pending First Circuit decision regarding the impact to their business or personal tax status and financial interests.
[1] 26 U.S.C. § 1, et seq.
[2] See Sirius Solutions, L.L.L.P., et. al v. Commissioner, No. 24-60240 (5th Cir. Jan. 16, 2026) (“Sirius Solutions”).
[3] See id.
[4] See Code Section 1401(a).
[5] See Code Section 1402(a).
[6] Soroban Capital Partners LP v. Commissioner, 161 T.C. 310 (2023).
[7] R.I. Gen. Laws § 7-13.1-101 et seq. (the “Uniform Limited Partnership Act”).
[8] See R.I. Gen. Laws § 7-13.1-301. There is no statutory requirement that a limited partner be a natural person; individuals can shield themselves and their business/financial interests with double limited liability protection as a limited partner that is itself a limited liability entity organized under state corporate law.
[9] See R.I. Gen. Laws § 7-13.1-303.
[10] See Denham Capital Management LP v. Commissioner, T.C. Memo. 2024-114 (Dec. 23, 2024), appeal pending Denham Capital Management LP v. Commissioner, No. 25-1349 (1st Cir. 2025).
About The Authors
Kristen R. Alberione
Kristen is Senior Counsel and Chair of the firm’s Tax Group. Her practice areas include federal and state tax resolution, corporate…
Matthew P. Bertelli
Matthew is a member of the firm’s Business & Corporate Law Group. Matthew has experience representing clients in matters concerning mergers…
