The Fifth Circuit says this is Sirius business: The IRS loses its fight against the limited partner exception to Self-Employment Contributions Act (SECA)

Upsetting a string of wins for the Internal Revenue Service ("IRS") in the Tax Court, the Fifth Circuit recently rejected the "functional analysis" test for determining whether a limited partner's partnership income is subject to tax under the Self-Employment Contributions Act ("SECA"). Instead, the Fifth Circuit concluded that the key question is whether the partner is entitled to limited liability under state law.

In a significant development for private equity fund managers, hedge funds, and other businesses organized as limited partnerships, the United States Court of Appeals for the Fifth Circuit rejected the US Tax Court's functional analysis test for the limited partner exception under Internal Revenue Code ("IRC") Section 1402(a)(13). See Sirius Solutions, L.L.L.P. v. Comm'r, No. 24-60240 (5th Cir. Jan. 16, 2026) (available here). Instead, a divided Fifth Circuit held that the statute's reference to a "limited partner, as such" means a partner in a limited partnership that has limited liability under state law.

The decision in Sirius is a major departure from Soroban Capital Partners LP v. Commissioner, 161 T.C. 310 (2023). In Soroban, the Tax Court held that the IRC Section 1402(a)(13) limited partner exception does not automatically apply to every state-law limited partner. The Tax Court concluded that Congress intended the statute to apply to "passive investors," and that a functional analysis is necessary to determine whether limited partners qualify. Last year, we discussed the rise and application of the functional analysis test in a post available here. At the Tax Court, the parties in Sirius stipulated that Soroban was precedential, and that the partnership's partners did not meet the functional analysis test. See Sirius Solutions, L.L.L.P. v. Comm'r, No. 30118-21 (T.C. Feb. 20, 2024).

In Sirius, the Fifth Circuit majority disagreed with the legal reasoning of the Tax Court in Soroban. The Fifth Circuit held that a "limited partner, as such" is a partner in a limited partnership that has limited liability under state law. The Fifth Circuit focused on the statutory text and the contemporaneous and longstanding interpretations of both the Social Security Administration and the IRS to support its decision. The Fifth Circuit also found the Tax Court's functional analysis approach in Soroban was unworkable in practice, reasoning that limited partners could not determine what their tax liability would be without extensive professional assistance.

The Fifth Circuit Sirius opinion also featured a dissent. The dissent concluded that a "limited partner, as such" must be a limited partner functioning as a limited partner, which requires behaving like a passive investor. Applying a functional analysis test, the dissent argued that the partnership's partners were "'limited' in name only."

Practice Point

The Fifth Circuit's decision in Sirius is a significant win for taxpayers in the Fifth Circuit, but its application in other jurisdictions remains unsettled. The Tax Court's functional analysis test from Soroban remains the test to be applied for taxpayers who are not in the Fifth Circuit, and the IRS is likely to continue litigating the issue aggressively. The Tax Court's Soroban approach was also applied in Denham Capital Management LP v. Commissioner, T.C. Memo. 2024-114. Both Denham and Soroban are on appeal, to two different Courts of Appeals. The outcomes of those cases (and the possibility of Supreme Court review) will determine how taxpayers are treated. In the meantime, limited partners should work with their tax advisors to both prepare a defensible functional analysis under Soroban and ensure their limited liability is well documented to satisfy the standard enunciated in Sirius.

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