A Tax Win for Limited Partners
A recent federal court decision furnishes limited partners with a significant tax victory. The Fifth Circuit Court of Appeals recently decided that limited partners are eligible for the self-employment tax exclusion under Section 1402(a)(13) of the Internal Revenue Code of 1986, as amended (the “Code”).
In Sirius Solutions, LLLP v. Commissioner,[1] a business consulting firm (“Sirius”) challenged an Internal Revenue Service (“IRS”) determination that its limited partners were subject to the federal self-employment tax.
Self-employment taxes are assessed on “net earnings from self-employment,” which includes a partner’s distributive share of income derived from any trade or business of a partnership which they are a member.[2] The controversy centered on an embattled provision of the Code, Section 1402(a)(13), which excludes the distributive share of income earned by a “limited partner” from gross income for purposes of the self-employment tax. Relying on this exception, Sirius reported $0 of net earnings from self-employment for all its limited partners in several yearly tax returns.
Following an audit, the IRS determined that the Section 1402(a)(13) exception did not apply “because none of Sirius’s limited partners counted as ‘limited partners’ for purposes of the statutory exception.” In one year, for example, the IRS adjusted Sirius’s net earnings from self-employment from $0 to $5,915,918. Sirius petitioned the Tax Court for a reassessment of its self-employment tax liability.
The Tax Court ruled in favor of the IRS. Relying on a recent decision, Soroban Capital Partners LP v. Commissioner,[3] the Tax Court reasoned that the Section 1402(a)(13) exception for “limited partners” only “refers to passive investors.” Sirius appealed and found a more favorable bench in the Fifth Circuit.
On appeal, the Fifth Circuit sided with Sirius. By drawing on statutory language, dictionary definitions, analogous laws, and IRS practice and procedure, the court discerned that “limited partner,” for purposes of Section 1402(a)(13), is not limited only to passive investors. Instead, the exclusion applies to any limited partner of a state-law limited partnership that is afforded limited liability. Therefore, Sirius was not required to report its limited partners’ distributive shares as net earnings from self-employment.
Practical Takeaway
While the Sirius decision is a major tax win for limited partners, the issue is far from decided. The Firth Circuit’s ruling is binding only in Texas, Louisiana, and Mississippi. It stands merely as persuasive authority in other federal appellate circuits, meaning that other appellate courts are not required to follow the Sirius decision. There are currently two cases pending in the Courts of Appeals for the First Circuit and Second Circuit that will also scrutinize the self-employment tax exclusion for limited partners.[4] Since the First Circuit and Second Circuit are not bound by the decision of the Fifth Circuit, these cases may have adverse results for limited partners.
As tax filing season ramps up, businesses and professional advisors should account for these changes. The KMK Law Tax Team will continue to closely monitor developments and provide updates as additional guidance becomes available.
[1] Case No. 24-60240 (5th Cir. 2026).
[2] I.R.C. § 1402(a).
[3] 161 T.C. 310 (2023).
[4] The First Circuit Court of Appeals includes Maine, Massachusetts, New Hampshire, Rhode Island, and the Commonwealth of Puerto Rico. The Second Circuit Court of Appeals encompasses Connecticut, New York, and Vermont.
