On January 16, 2026, the United States Court of Appeals for the Fifth Circuit issued a ruling defining the term \u201climited partner\u201d as used in the Internal Revenue Code of 1986, as amended[1]<\/a> (the \u201cCode\u201d). The Court held that a \u201climited partner\u201d is any partner that, under state limited partnership law, has limited liability status.[2]<\/a> In reaching this decision, the Fifth Circuit overturned the United States Tax Court (the \u201cTax Court\u201d) ruling, rejecting the previous and more narrow approach of excepting only partners that are \u201cpassive investors\u201d in a limited partnership.[3]<\/a> The decision enables limited partners to qualify for an exception from self-employment tax for \u201cthe distributive share of any item of income or loss of a limited partner, as such,\u201d under Section 1402(a)(13) of the Code (the \u201cException\u201d) without inquiry into the management roles and responsibilities of the limited partners.<\/p>\n\n\n\n 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]<\/a> Generally, a partner\u2019s distributive share of partnership income is subject to self-employment tax, unless an exception applies.[5]<\/a><\/p>\n\n\n\n Sirius Solutions, L.L.L.P. (\u201cSirius\u201d), 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\u2019s partnership income allocations. For the 2014\u20132016 tax years, Sirius reported no self\u2011employment earnings, asserting that its limited partners qualified for the Exception. The IRS disagreed, determining that the partners\u2019 roles did not align with the statutory definition of \u201climited partner,\u201d and issued adjustments totaling several million dollars in self\u2011employment tax. Sirius appealed the IRS determination to the Tax Court. The Tax Court sided with the IRS following its precedent that the term \u201climited partners\u201d only refers to passive investors.[6]<\/a><\/p>\n\n\n\n On appeal, the Fifth Circuit rejected the Tax Court\u2019s conventional \u201cpassive investor\u201d standard and held that a partner in a limited partnership qualifies as a \u201climited partner\u201d for purposes of the Exception if the partner has limited liability. Since the Code does not define what constitutes a \u201climited partner\u201d 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 \u201climited partner\u201d is most appropriately defined by the partner\u2019s limited liability status.<\/p>\n\n\n\n The Fifth Circuit\u2019s bright line rule considers only a partner\u2019s 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.<\/p>\n\n\n\n The Fifth Circuit\u2019s 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.<\/p>\n\n\n\n Notably, the Fifth Circuit\u2019s decision did not limit its reasoning to any particular enterprise. Therefore, the Fifth Circuit\u2019s 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\u2019s 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.<\/p>\n\n\n\n Rhode Island and other jurisdictions in New England have enacted limited partnership statutes.[7]<\/a> 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]<\/a> Limited partners in Rhode Island limited partnerships receive explicit statutory limited liability protection.[9]<\/a> Accordingly, limited partners in Rhode Island limited partnerships should qualify as \u201climited partners\u201d for purposes of the Exception under the Fifth Circuit\u2019s ruling.<\/p>\n\n\n\n Sirius Solutions<\/em> is one of several cases in which the Tax Court adopted the government-friendly passive investor standard, and the Fifth Circuit\u2019s rejection of the Tax Court\u2019s 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]<\/a> If the First Circuit reaches a different conclusion, creating a circuit split, the United States Supreme Court may grant certiorari, given the issue\u2019s 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\u2019s jurisdiction, partners that claim the Exception while materially participating in limited partnership business management and affairs may continue to face IRS challenges.<\/p>\n\n\n\n Readers are encouraged to contact Kristen Alberione or Matthew Bertelli at kalberione@apslaw.com<\/a> or mbertelli@apslaw.com<\/a>, respectively, for more information about Sirius Solutions<\/em>, the Exception, and the pending First Circuit decision regarding the impact to their business or personal tax status and financial interests.<\/p>\n\n\n\n [1]<\/a> 26 U.S.C. \u00a7 1, et seq. <\/p>\n\n\n\n [2]<\/a> See Sirius Solutions, L.L.L.P., et. al v. Commissioner<\/em>, No. 24-60240 (5th Cir. Jan. 16, 2026) (\u201cSirius Solutions<\/em>\u201d).<\/p>\n\n\n\n [3]<\/a> See<\/em> id.<\/p>\n\n\n\n [4]<\/a> See<\/em> Code Section 1401(a).<\/p>\n\n\n\n [5]<\/a> See<\/em> Code Section 1402(a).<\/p>\n\n\n\n [6]<\/a> Soroban Capital Partners LP v. Commissioner<\/em>, 161 T.C. 310 (2023).<\/p>\n\n\n\n [7]<\/a> R.I. Gen. Laws \u00a7 7-13.1-101 et seq. (the \u201cUniform Limited Partnership Act\u201d).<\/p>\n\n\n\n [8]<\/a> See<\/em> R.I. Gen. Laws \u00a7 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.<\/p>\n\n\n\n [9]<\/a> See<\/em> R.I. Gen. Laws \u00a7 7-13.1-303.<\/p>\n\n\n\nBackground<\/h2>\n\n\n\n
Decision<\/h2>\n\n\n\n
Analysis and Impact<\/h2>\n\n\n\n
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