Stay Tuned: Fifth Circuit Reverses the Functional Test for Limited Partners and Self-Employment Tax

Recent court decisions have reignited uncertainty around when limited partners may be subject to self-employment tax, an issue that has long been debated by taxpayers, practitioners, and the IRS.

In January 2026, the Fifth Circuit Court of Appeals vacated and remanded the Tax Court’s decision in Sirius Solutions LLLP v. Commissioner, rejecting the “functional test” used by the IRS and the Tax Court to determine whether limited partners owe self-employment tax on their distributive share of partnership income.

This decision comes on the heels of the Tax Court’s 2023 ruling in Soroban Capital Partners LP v. Commissioner, where the court concluded that the partners were not limited partners for purposes of self-employment because it was clear that the partners’ income did not arise as a return on the partners’ investment and were not earnings which are basically of an investment nature.

Together, these cases have created a meaningful split in how courts interpret the limited partner exception under Internal Revenue Code Section 1402(a)(13).

Why This Reminder Matters Now

The Fifth Circuit’s decision creates a divide between courts. The IRS and the Tax Court continue to apply a functional, facts and‑circumstances test, while the Fifth Circuit has adopted an interpretation tied to state law limited liability status.

For taxpayers in the Fifth Circuit (Texas, Louisiana, and Mississippi), this ruling potentially broadens the number of limited partners in state law limited partnerships or LLLP’s who can exclude their distributive share of income from self-employment tax.

Stay Tuned

This issue is far from settled. With conflicting decisions, potential appeals, and the possibility of future IRS guidance or regulatory action, the treatment of limited partners remains in flux.

Partnerships and their advisors should closely monitor developments and consider how these cases may impact current structures, compliance positions, planning opportunities, and open tax years.

Sources: Summary based on recent case law analysis, including Soroban Capital Partners v. Commissioner and Sirius Solutions LLLP v. Commissioner.