A look at what the Fifth Circuit’s new limited-partner standard could mean for self-employment tax.
Some people think tax is boring.
To me, it is an ongoing telenovela: competing interpretations, unexpected reversals, appellate drama, and just when you think you understand where the story is going, somebody files for rehearing.
The latest example is K Alain, L.L.L.P. v. Commissioner, decided by the Fifth Circuit on August 12, 2026.
At the center of the case is a surprisingly simple question:
What exactly is a “limited partner”?
That may seem like something the Internal Revenue Code would define.
It does not.
And that omission has turned into a heated debate over self-employment tax.
The Problem
Ordinarily, a partner’s share of income from a partnership’s trade or business is included in net earnings from self-employment.
But Section 1402(a)(13) creates an exception: a limited partner’s share of partnership profits is generally excluded from self-employment income.
The problem is that Congress used the term “limited partner” without telling us exactly what it means for purposes of this particular rule.
So the courts have had to answer the question themselves:
Does “limited partner” simply mean someone who is legally designated as a limited partner? Or does it depend on what that person actually does for the business?
First Came Soroban
In Soroban Capital Partners LP v. Commissioner, 161 T.C. 310 (2023), the Tax Court took what is commonly called a functional approach.
In simpler terms, the court said the label alone was not enough.
A partnership could not simply call someone a limited partner and assume that the person’s share of the profits automatically escaped self-employment tax.
Instead, the Tax Court wanted to know what the partner actually did.
Was this person a passive investor?
Or was the partner actively performing the work of the business?
Under Soroban, a partner who was heavily involved in providing services to the partnership could have difficulty qualifying for the limited-partner exception, even if state law and the partnership agreement called that person a limited partner.
Sirius Solutions Changes the Story
On January 16, 2026, the Fifth Circuit issued an opinion in Sirius Solutions, L.L.L.P. v. Commissioner.
And it went in a very different direction.
The court essentially said that if state law recognizes someone as a limited partner and that person is not personally responsible for the partnership’s debts, then the individual qualifies as a “limited partner” for purposes of Section 1402(a)(13).
In other words, a person’s participation or active involvement in the business did not determine whether they qualified as a limited partner.
That was a major departure from Soroban and a substantial victory for taxpayers.
Under that approach, the legal structure of the partnership carried enormous weight.
But the story was not over.
The government asked the Fifth Circuit to reconsider.
And the Fifth Circuit did.
The August Reversal
On August 12, 2026, the Fifth Circuit withdrew its January Sirius Solutions opinion and issued a new opinion under the partnership’s new name: K Alain, L.L.L.P. v. Commissioner, No. 24-60240 (5th Cir. Aug. 12, 2026).
And with it came a new rule.
The court said that a limited partner is someone who plays “no significant role in managing or running a business.”
That is importantly different from both Soroban and the Fifth Circuit’s original Sirius opinion.
The Fifth Circuit did not return to the Tax Court’s passive-investor standard.
Instead, the court looked at how limited partnerships were understood when Congress enacted Section 1402(a)(13) in 1977.
The court concluded that limited partners historically could do more than simply invest money and sit quietly on the sidelines, so some participation was permitted.
Why K Alain Matters
The August decision lands somewhere between the Tax Court’s Soroban approach and the Fifth Circuit’s original Sirius opinion.
It is less taxpayer-friendly than the January Sirius decision, because simply being a state-law limited partner with limited liability is no longer enough.
But K Alain is also more taxpayer-friendly than Soroban, because the Fifth Circuit rejected the idea that a limited partner must necessarily be a completely passive investor.
A person may potentially perform services or participate in the partnership without automatically losing the limited-partner exception.
The real question is whether that participation rises to the level of significant management or control.
The Fifth Circuit also did not ultimately decide whether the K Alain partners themselves qualify for the exception.
Instead, it sent the case back to the Tax Court to reconsider the facts using this new standard.
And the Story Is Not Over
Two other closely watched cases involve the same limited-partartner question.
Soroban is currently before the Second Circuit.
Denham Capital Management is before the First Circuit.
If those courts adopt the same reasoning as K Alain, we may begin to see a more consistent national standard.
If they do not, taxpayers could end up facing different interpretations of the same federal tax provision depending on where their case is heard.
That would create a genuine circuit split, and potentially make the issue a stronger candidate for Supreme Court review.
So, for now, K Alain gives us an important new rule, but not necessarily the final answer.
A limited partner does not have to sit silently on the sidelines.
But simply putting the words “limited partner” next to someone’s name is not enough either.
The question is increasingly becoming:
What role does this person actually play in running the business?
Apparently, Section 1402(a)(13) still has a few plot twists left.
Sources
K Alain, L.L.L.P. v. Commissioner*, No. 24-60240 (5th Cir. Aug. 12, 2026).
Sirius Solutions, L.L.L.P. v. Commissioner*, 165 F.4th 374 (5th Cir. 2026), opinion withdrawn and superseded by *K Alain*.
Soroban Capital Partners LP v. Commissioner*, 161 T.C. 310 (2023).
Denham Capital Management LP v. Commissioner*, T.C. Memo. 2024-114, appeal pending in the First Circuit.
No comments:
Post a Comment