As the name implies, a limited partner in a partnership is a partner, in contrast to a general partner, who has liability for partnership debts only to the extent of the limited partner’s investment in the partnership. The majority in a recent case uses these definitions of limited partner under state and federal law to conclude that being a limited partner did not require being a passive investor, other than in the context of guaranteed payments under Code Sec. 707(c).
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The issue involved in Sirius (Sirius Solutions L.L.L.P. v Commissioner, No. 24-60240 (5th Cir. Jan. 16, 2026)) was the self-employment tax liability of limited partners under Code Sec. 1402(a)(13). The Internal Revenue Service has developed a functional analysis looking at a partner’s level of participation to determine whether the partner is subject to self-employment tax.
A limited partner’s distributive share of partnership income is generally excluded from self-employment tax except for guaranteed payments for services. Code Sec. 469 treats limited partner interests as per se passive activities unless the taxpayer meets material participation standards. Reg. Sec. 1.469-5T defines active participation as only satisfying one of three limited material participation tests, compared to seven for nonlimited partners. In practice, many limited partners become functional general partners under these tests.
Looking at historical definitions of limited partner, state law under limited partner statutes, and even IRS language in forms and instructions, the Fifth Circuit case was heard by a three-judge panel. The two-judge majority concluded that there was no support for introducing a passive investor requirement to be a limited partner, and concluded that a limited partner could not be subject to self-employment tax under those requirements, reversing the Tax Court on the same issue. A limited partner is simply a state-law limited partner with limited liability, with no functional analysis required. The dissent filed by the third judge was in support of the Tax Court position.
The IRS has not accepted the Fifth Circuit decision. As of this writing, it is not clear whether the agency will seek an en banc review by the Fifth Circuit or petition the Supreme Court. The appeal deadline for Sirius is March 2, 2026.
Passive investor
The majority in Sirius focused on the lack of any specific references to a passive investor requirement in early definitions of limited partner. The IRS argued that a lack of passive activity was assumed in the definition of limited partner.
The Sirius majority pointed out that the Form 1065 instructions for years stated that limited partners treat as self-employment earnings only guaranteed payments for services they actually rendered to or on behalf of the partnership. Only in 2022 did the IRS add: “However, whether a partner qualifies as a limited partner for purposes of self-employment tax depends upon whether the party meets the definition of limited partner under Code Sec. 1402(a)(13).”
Related cases
The Tax Court in Sirius had cited its previous decision in Soroban Capital (151 T.C. 310 (2003)). That decision is on appeal to the Second Circuit. Another case, Denham Capital (T.C. Memo 2014-114), was similarly decided by the Tax Court as a memorandum decision and is currently on appeal to the First Circuit.
It is anticipated that one or both circuits will issue opinions on these same issues within the next year. Many commentators feel it is likely that one or both of those cases may create a conflict among the circuits and make the case ripe for petition to the Supreme Court.
Planning
Taxpayers in the Fifth Circuit, composed of Louisiana, Mississippi and Texas, may want to consider whether limited partnerships should now alter their treatment of self-employment income of limited partners under Sirius and whether limited partners should file refund claims in response to the Sirius decision. Although it might also make sense to hold off until further circuit courts and the Supreme Court address the issue, those taxpayers with statute of limitations issues may want to at least file protective refund claims. Taxpayers outside of the Fifth Circuit may also wish to file protective refund claims in the event that the Fifth Circuit position ends up prevailing. It is also possible that Congress could consider trying to resolve the issue through legislation.
Limited partners seeking refunds may also have to negotiate with the partnership involved to seek the partnership’s involvement to amend the K-1s at issue. Otherwise, they would be filing a refund claim inconsistent with the K-1 on file with the IRS.
The Fifth Circuit majority seemed to try to limit its decision to limited partnership situations. It is not clear that limited liability companies may similarly seek to rely on the decision.
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