Fifth Circuit flips the limited partner SE tax standard

Determining when a partner’s distributive share is subject to self-employment tax remains one of the most complex areas of partnership taxation. On Aug. 12, 2026, the U.S. Court of Appeals for the Fifth Circuit significantly reshaped this landscape by withdrawing its prior opinion and substituting a new standard in K. Alain LLLP v. Commissioner, formerly Sirius Solutions LLLP v. Commissioner. For cases appealable to the Fifth Circuit, the bright-line limited liability test is gone, replaced by an inquiry into a partner’s management and control.

The statutory framework of §1402(a)(13)

Section 1401(a) imposes tax on the self-employment income of every individual. Section 1402(b) generally defines self-employment income as net earnings from self-employment derived by an individual during the taxable year.

• Section 1402(a): Net earnings from self-employment generally include an individual’s gross income from a trade or business, along with the individual’s distributive share of income or loss from a partnership trade or business.
• Section 1402(a)(13): A limited partner’s distributive share of partnership income or loss is excluded, except for guaranteed payments under §707(c) for services actually rendered to or on behalf of the partnership.

From limited liability to management and control

In January 2026, the Fifth Circuit initially held that the term “limited partner” simply referred to a partner in a state-law limited partnership that afforded limited liability. This bright-line rule provided temporary certainty but was short-lived. In its revised August 2026 opinion, the court moved away from liability status alone.

The court now holds that the original public meaning of a limited partner is a partner who plays no significant role in managing or running a business. This definition is grounded in dictionary meanings and the historical context provided by the Uniform Limited Partnership Act (ULPA), under which limited partners could lose their liability protection if they took part in controlling the business.

This revised standard creates a managerial versus nonmanagerial distinction. While the court rejected the Tax Court’s Soroban passive-investor test, which it viewed as prohibiting even minor involvement, it nonetheless established that significant participation in managing or running the business prevents a partner from qualifying for the §1402(a)(13) exception.

The Fifth Circuit steps in, twice

In a Delaware limited liability limited partnership case involving a Houston-based consulting firm, the IRS adjusted the partnership’s net earnings from self-employment by millions of dollars, arguing the partners were not truly limited partners for federal tax purposes. The Tax Court agreed with the IRS.

The Fifth Circuit did not. In its original opinion, the court held that limited liability under state law was the deciding factor, full stop. Then, on rehearing, the court withdrew that opinion and replaced it with a more nuanced standard. Under the revised opinion, the ordinary public meaning of limited partner turns on whether the individual plays a significant role in managing or running the business, not simply whether the individual’s liability is capped under state law.

Interaction with guaranteed payments

It is crucial to differentiate between distributive shares and guaranteed payments. Section 707(c) identifies payments to a partner for services or the use of capital that are determined without regard to partnership income. Even if a partner qualifies for the limited partner exception for a distributive share, guaranteed payments received for services actually rendered to or on behalf of the partnership remain subject to self-employment tax.

Practical analysis and unresolved issues

To determine whether a taxpayer meets the new no-significant-role threshold, practitioners should evaluate the partner’s actual activities. Relevant documentation may include:

• A detailed record of the partner’s responsibilities and time devoted to the entity
• Evidence of the partner’s authority to make significant business decisions, such as hiring or firing staff and negotiating client engagements

The outcome changes at the significance threshold. The court indicated that some nonmanagerial participation may be permissible, but it did not define precisely how much involvement becomes significant management or control. Practitioners must therefore evaluate the nature and extent of each partner’s role.

The revised opinion also does not resolve the treatment of LLC members. Because the court’s analysis focused on the historical meaning of limited partner, practitioners should not assume that the new test extends to LLC members.

What this means for your advisory conversations

Even a partner who clears the limited partner bar can still owe self-employment tax on guaranteed payments received for services actually rendered under §707(c). Separating a distributive share from a guaranteed payment remains important.

Documentation is your client’s best defense. Partnership agreements, governing documents and contemporaneous records of each partner’s actual role now carry real weight. Waiting until an audit to determine the partner’s responsibilities is not a strategy. Geography still matters. The decision controls cases appealable to the Fifth Circuit, which includes Texas, Louisiana and Mississippi. Taxpayers whose cases are appealable elsewhere should not assume that another court will apply the same reasoning.

Cases like this move fast, and practitioners who understand the shift early can protect their clients before the next audit letter arrives. If you have clients holding limited partnership interests or regularly structure partnership compensation, this is not a topic to learn about after the fact.

NATP's Latest Guidance for Self-Employment Taxes and Partners webinar is designed to help tax professionals confidently address these issues. Register today and strengthen your ability to analyze partnership and LLC income in one of the most closely watched areas of tax law.