Second Circuit Affirms Tax Court, Adopts Management-Based Standard for Limited Partner Self-Employment Tax Exception
On September 17, 2026, the Second Circuit weighed in on the meaning of "limited partner" for purposes of Section 1402(a)(13), which excludes a limited partner's distributive share of partnership income from self-employment tax. In Soroban Capital Partners LP v. Commissioner, the court held that a limited partner is one who has both limited liability and “does not run, manage, or otherwise exert control or managerial authority over the partnership.” Because Soroban’s principals worked full time running the hedge fund investment manager, the court held they could not qualify for the limited partner exception and were subject to self-employment tax on their distributive shares of partnership income.
In our previous advisory, we reported that the Fifth Circuit adopted its own management-based standard last month in K Alain L.L.L.P. v. Commissioner, rejecting the argument that a state-law limited partner label controls. Instead, the court held that a limited partner is "a partner who plays no significant role in managing or running a business." (Emphasis added.)
Both courts rely on the ordinary meaning of “limited partner” at the time Section 1402(a)(13) was enacted and recognize that some participation is permissible. However, neither court provides clear guidance on when a partner’s involvement in the partnership crosses into impermissible management or control of the business.
The Soroban Decision
Soroban Capital Partners LP is a Delaware limited partnership that serves as an investment manager to a group of hedge funds. Its three principals were state-law limited partners of Soroban and members of its general partner.
Although Soroban’s partnership agreement vested management, operations, and control exclusively in the general partner, the principals worked approximately 2,300 to 2,500 hours per year managing portfolio investments, served on nearly all governing committees, participated in key personnel decisions, and oversaw senior management.
Invoking the limited partner exception in Section 1402(a)(13), Soroban excluded the principals’ distributive shares from self-employment tax. The Tax Court rejected that position, concluding the principals were “limited partners in name only,” and the Second Circuit affirmed.
The Second Circuit’s standard turns on whether a partner controls, manages, or runs the business. At the same time, it acknowledged that providing some services does not necessarily amount to running the business. Applying that standard, the court concluded the principals were not limited partners because they exercised managerial control over Soroban and played a critical role in generating its income.
Addressing the Fifth Circuit's recent K Alain decision, the court found “little daylight” between the Fifth Circuit’s test, under which a limited partner plays no significant role in managing or running the business, and the Tax Court's view in Soroban that a limited partner generally resembles a passive investor. The court further observed that Soroban’s principals would also fail the Fifth Circuit’s standard because they “clearly played” a “significant role” in managing the business.
Broader Implications
With two circuits now rejecting a bright-line test and adopting management-based standards, the opinion has broad implications for investment managers and their limited partners claiming the limited partner exception. It also arrives after the extended due date for 2025 calendar-year partnership returns but before the extended due date for 2025 individual returns, raising potential filing questions for taxpayers on extension.
Each circuit articulates a slightly different functional test whose application remains unclear, leaving uncertainty for limited partners whose involvement falls between passive investment and significant management, as well as for LLC members and other non-state-law limited partners.
The First Circuit's pending appeal in a similar Tax Court case, Denham Capital Management, could further solidify the emerging consensus, apply yet another functional approach, or create a circuit split.
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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