Limited Partners Just Won Big: Fifth Circuit Rejects IRS "Passive Investor" Test

The Fifth Circuit just handed business owners a significant victory. On January 16, 2026, in Sirius Solutions, L.L.L.P. v. Commissioner, the court held that a "limited partner" under 26 U.S.C. § 1402(a)(13) means exactly what it says: a partner in a limited partnership with limited liability under state law. No multi-factor balancing test. No subjective inquiry into how "passive" you are.

This ruling directly overturns the Tax Court's 2023 decision in Soroban Capital Partners LP v. Commissioner, which had created chaos by imposing a "functional analysis test" that essentially asked: does this limited partner act like a passive investor? Under Soroban, limited partners who actively participated in their businesses were hit with unexpected self-employment tax bills running into the millions—even when properly designated under state law.

What the Court Said

The Fifth Circuit rejected the "passive investor" approach entirely. Writing for a divided court, Judge Andrew Oldham emphasized that courts must apply "the ordinary meaning" of statutory terms at the time of enactment. In 1977, when Congress enacted § 1402(a)(13), every contemporaneous dictionary defined "limited partner" based on one characteristic: limited liability.

Section 1402(a)(13) excludes from self-employment tax "the distributive share of any item of income or loss of a limited partner, as such, other than guaranteed payments described in section 707(c) to that partner for services actually rendered." The statute itself contemplates that limited partners would perform services—that's why Congress included the "guaranteed payments" exception. If "limited partner" meant only passive investors, that entire clause would be superfluous.

The phrase "as such" doesn't narrow the definition; it clarifies how dual-status partners should be taxed. When you're functioning as a limited partner, the exclusion applies; when you're functioning as a general partner, it doesn't.

Bottom Line

If you're operating a business in the Fifth Circuit as a limited partnership with state-law limited liability protection, Sirius Solutions provides clarity: your distributive share of partnership profits is excluded from self-employment tax. You'll still owe self-employment tax on guaranteed payments for services rendered, but partnership profits flow through without the 15.3% SECA hit.

One caveat: the Fifth Circuit did not address whether LLC or LLP members qualify for this exception. That question remains open, though the court's emphasis on limited liability suggests a framework for analyzing those structures.

This post is for informational purposes only and does not constitute legal or tax advice. Consult with qualified legal and tax professionals before making entity selection decisions. If you’re ready to consult on entity selection or other outside general counsel needs, contact Elkhoury Law today.