In August 2026, the Fifth Circuit withdrew its January opinion in Sirius Solutions L.L.L.P. v. Commissioner and issued a substitute opinion under the new caption K Alain L.L.L.P. v. Commissioner. The court had denied rehearing en banc, instead granting a panel rehearing where it held that the meaning of “limited partner” for purposes of Section 1402(a)(13) is a partner who “plays no significant role in managing or running a business.” The court vacated the Tax Court’s decisions and remanded for further proceedings under the new standard.
The substitute opinion materially narrows the taxpayer victory in the January opinion, which had created a bright-line test and had treated state law limited partner status and limited liability as sufficient. It does not, however, adopt the Tax Court’s rule articulated in Soroban Capital Partners LP v. Commissioner that the exception is limited to passive investors. Instead, the Fifth Circuit establishes a middle category in which a partner may participate in certain aspects of the business without playing a significant role in managing or running it. The opinion leaves substantial uncertainty about where permissible participation ends and disqualifying management or control begins.
Background
Section 1402(a) generally includes in an individual’s net earnings from self-employment the individual’s distributive share of income or loss from a partnership trade or business. Section 1402(a)(13), however, excludes the distributive share of a “limited partner, as such,” other than guaranteed payments under Section 707(c) for services actually rendered to or on behalf of the partnership. The distinction generally determines whether the distributive share is subject to Social Security and Medicare taxes imposed on self-employment income.
Congress enacted the limited partner exception in 1977. At that time, limited-partnership law generally distinguished between general partners who managed or controlled the partnership’s business and limited partners who contributed capital and whose participation in control could jeopardize their limited-liability protection. Modern limited-partnership statutes have substantially relaxed the relationship between participation and limited liability, permitting limited partners to perform services and participate in a partnership’s affairs without necessarily becoming liable as general partners.
The resulting divergence between historical limited-partnership concepts and modern state-law entities has produced significant uncertainty under Section 1402(a)(13). In cases including Renkemeyer, Campbell & Weaver LLP v. Commissioner and Soroban, the Tax Court developed a functional test that looks beyond state-law status to the partner’s actual functions and responsibilities and to whether the partner’s earnings are in the nature of a return on investment.
In Soroban, the Tax Court held that state law limited partner status was not sufficient and that the term “limited partner, as such” referred to a partner functioning as a passive investor. The Tax Court therefore required an examination of the partners’ roles in generating the partnership’s income, their participation in the business, and the relationship between their capital contributions and distributive shares.
The Sirius Dispute and the January Opinion
Sirius was a Delaware limited liability limited partnership (LLLP) that operated a business-consulting firm based in Houston, with additional offices in Dallas and London. In 2014, Sirius had nine individual limited partners and a separate general-partner entity holding less than 1% of the partnership. Four limited partners disposed of their interests during 2014, leaving five individual limited partners for 2015 and 2016.
Sirius reported approximately $5.8 million of ordinary business income in 2014, approximately $7.2 million in 2015, and an ordinary business loss of approximately $490,000 in 2016. It allocated all that income or loss to the individual limited partners but reported no net earnings from self-employment attributable to those allocations.
The IRS determined that the individual partners were not “limited partners” for purposes of Section 1402(a)(13) and adjusted Sirius’s net earnings from self-employment by the approximate amounts Sirius reported as ordinary business income. The Tax Court upheld the adjustments based on its opinion in Soroban, and Sirius appealed.
In January 2026, a divided Fifth Circuit panel vacated the Tax Court’s decisions and held that a “limited partner” was a partner in a state law limited partnership who had limited liability. Under that rule, a partner’s activities in the partnership’s business would not, by themselves, prevent the partner from qualifying for the exception. The opinion provided a relatively clear rule for state law limited partners, although it expressly did not resolve the treatment of members or partners in other types of entities, such as limited liability companies (LLCs) and limited liability partnerships (LLPs).
The Substitute Opinion
The government petitioned the Fifth Circuit for rehearing en banc. The court denied en banc review but treated the petition as also requesting a panel rehearing and granted that request. The panel withdrew the January opinion and replaced it with a substantially revised per curiam opinion.
The substitute opinion holds that the original meaning of “limited partner” in 1977 was a partner who played no significant role in managing or running a business. In reaching this conclusion, the majority relied on contemporaneous legal dictionaries, the Uniform Limited Partnership Act of 1916 and its 1976 revision, historical treatises, and case law distinguishing partners who controlled partnership affairs from partners with lesser forms of involvement.
The court concluded that historical limited partnership law did not demand complete passivity. It cited authority suggesting that some participation was permissible so long as the partner did not exercise control over the business and stated that a limited partner could perhaps participate in certain nonmanagerial aspects of the business. The court therefore drew a distinction between managerial and nonmanagerial participation rather than between all activity and complete passivity.
On that basis, the Fifth Circuit expressly rejected the Tax Court’s Soroban rule. The court criticized Soroban as appearing to prohibit even minor involvement in partnership affairs and as failing to ground its passive investor standard in the original public meaning of “limited partner.” The court also emphasized that IRS Form 1065 instructions had, for decades, defined limited partners principally by reference to limited liability, without identifying a control or passive investor test.
At the same time, the substitute opinion abandons the January opinion’s conclusion that limited liability is sufficient. The federal tax inquiry now depends on the partner’s role in the business, not merely the partner’s classification and liability protection under state law.
The Fifth Circuit did not determine whether the Sirius partners played significant roles in managing or running the consulting business. It instead vacated and remanded for further proceedings under the new standard.
In dissent, Judge Graves would have affirmed the Tax Court on the ground that Section 1402(a)(13) applies only to partners functioning as passive investors. He also criticized the majority’s management-based test as lacking sufficient definition and warned that it could permit substantial earnings attributable to active business participation to escape self-employment tax.
Significance of the Decision
The substitute opinion leaves taxpayers with a significantly less favorable but more nuanced standard than the bright-line test in the January opinion. State law limited partner status and limited liability are no longer sufficient. But the Fifth Circuit also makes clear that participation in the partnership’s business is not automatically disqualifying.
The relevant distinction under K Alain is therefore not simply whether a partner is “active” or “passive.” The question is whether the partner plays a significant role in managing or running the business. A partner may perform some services or participate in certain nonmanagerial activities and still potentially qualify for the exception. A partner who materially directs, controls, or operates the business is less likely to qualify.
However, the court did not define what constitutes a “significant role” or identify controlling factors. Open questions include whether formal authority must be exercised or merely exist, when operational responsibilities amount to “running” the business, how dual-capacity arrangements should be treated, and whether the source of income or relationship between capital and distributions matters.
These questions are particularly important when limited partners provide substantial services but management authority is formally vested elsewhere; formal separation may not control if they in fact direct or run the business. At the same time, K Alain supports the view that services and activity alone are not disqualifying. A partner may perform advisory, investment, client-facing, or other functions without exercising significant management authority, though the distinction remains fact-dependent.
With 2025 tax returns on extension due imminently, partnerships and their partners must now evaluate their reporting positions under a new standard whose contours are uncertain.
Broader Implications
The K Alain decision will govern Tax Court cases appealable to the Fifth Circuit. Outside the Fifth Circuit, the Tax Court can be expected to continue applying its own Soroban precedent unless the applicable appellate court adopts a different standard.
Appeals involving the limited partner exception are pending in the First Circuit in Denham Capital Management LP v. Commissioner and in the Second Circuit in Soroban. The parties have brought the substitute K Alain opinion to those courts’ attention. The government has argued that the partners in those cases played significant roles in managing or operating their investment management businesses and therefore fail even the Fifth Circuit’s new test. The taxpayers, in turn, will emphasize that K Alain expressly rejected the Tax Court’s passive investor rule and permitted at least some nonmanagerial participation and may continue to argue for a bright-line test consistent with the Fifth Circuit’s interpretation of the statutory language in its January opinion. The parties in K Alain may request en banc rehearing or petition for certiorari to the Supreme Court.
The forthcoming appellate decisions may clarify the distinction between passive investment, nonmanagerial participation, and significant management. They also may produce different standards among the circuits, particularly if another appellate court adopts the Tax Court’s passive investor approach or a different functional test.
Partnerships taking positions under Section 1402(a)(13) should therefore conduct a partner-by-partner review of both formal authority and actual conduct. Relevant considerations may include authority over business or investment strategy, budgets, personnel, compensation, client or investor relationships, significant contracts, allocation of firm resources, and day-to-day operations. Organizational documents, committee arrangements, employment descriptions, public biographies, internal communications, and actual decision-making practices should be evaluated together.
Conclusion
K Alain removes the certainty supplied by the Fifth Circuit’s January opinion without adopting Soroban’s passive-investor rule. State law limited partner status and limited liability are no longer sufficient, but complete passivity is not required. Taxpayers evaluating the Section 1402(a)(13) exception should focus on each partner’s actual authority and activities and, in particular, whether the partner plays a significant role in managing or running the business.
Until the Tax Court applies the new standard on remand and the other appellate courts address the issue, substantial uncertainty—and potentially differing standards among jurisdictions—will remain.
If you have any questions, or would like additional information, please contact one of the attorneys on our Federal & International Tax team.
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