Fifth Circuit Redefines "Limited Partner" for Self-Employment Tax
On August 12, 2026, the Fifth Circuit did something rare: it withdrew its own opinion in Sirius Solutions, L.L.L.P. v. Commissioner and issued a substituted opinion in its place, just months after the original ruling. The statute at issue, 26 U.S.C. § 1402(a)(13), excludes a limited partner's distributive share of partnership income from "net earnings from self-employment" (i.e., from Social Security and Medicare tax), with an exception for guaranteed payments for services actually rendered. For nearly fifty years, the working assumption in the Fifth Circuit was that "limited partner" meant a partner with limited liability under state law, regardless of involvement in the business. The Fifth Circuit's new opinion abandons that assumption.
In the withdrawn opinion, the panel had held that "limited partner" for tax purposes tracked state-law limited liability status alone, echoing the reading the IRS itself used in Form 1065 instructions dating back to 1978. The substituted opinion instead holds that the original public meaning of "limited partner" under § 1402(a)(13), as understood in 1977, is a partner who plays no significant role in managing or running the business.
This new rule sits between two poles. The court expressly rejected the Tax Court's 2023 decision in Soroban Capital Partners LP v. Commissioner, which held that a limited partner must be a purely "passive investor" to qualify for the exclusion, calling that standard untethered to any 1977-era authority. But the Fifth Circuit's functional test is also narrower than a pure state-law-label test: a limited partner who exercises real managerial control over the business will not qualify for the exclusion, no matter what the partnership agreement or state formation documents call that person.
Based on this new opinion, entity labels and limited-liability formalities are no longer sufficient, on their own, to guarantee the self-employment tax exclusion for limited partners in the Fifth Circuit. This creates real planning risk for professional-services partnerships, consulting firms, and investment vehicles where individuals formally titled "limited partners" nonetheless perform substantial services for, or exercise real influence over, the business—signing client engagements, managing staff, or setting strategy.
Businesses and their partners in Texas and across the Fifth Circuit should revisit both their governance documents and their real-world conduct in light of this shift. Key steps include auditing whether limited partners' actual day-to-day roles match their paper status, reassessing guaranteed payment structures (which remain taxable regardless of limited-partner status), and considering whether managerial functions currently performed by limited partners should be delegated to a general partner or manager entity.
If you are a limited partner with active involvement in your partnership's business, it may be time to reassess your business structuring in light of this decision. Elkhoury Law advises businesses and their owners on entity structuring, partnership agreements, and the governance choices that follow from decisions like this one. Contact Elkhoury Law to discuss how this ruling may affect your partnership structure.
