Fifth Circuit Narrows Limited Partner Exception to Self-Employment Tax

By way of background, IRC Section 1402(a)(13) excludes a limited partner's distributive share of partnership income from Social Security and Medicare taxes. In recent years, the IRS has attempted to limit the overall exception to passive investors in state law limited partners, applying a functional analysis test to determine whether partners qualified. On January 16, the Fifth Circuit held in Sirius Solutions L.L.L.P. v. Commissioner, 165 F.4th 374 (5th Cir. 2026) that whether a partner in a state law limited partnership is a "limited partner" depends only on whether that partner has limited liability under state law, and not on the partner's level of participation in the business. On rehearing in K Alain, L.L.L.P. v. Commissioner, No. 24-60240 (Aug. 12, 2026), the Fifth Circuit withdrew Sirius in favor of a new interpretation. In K Alain, the Fifth Circuit introduced an activity-based (or role-based) standard to hold that a "limited partner" is a partner who does not take part in managing or controlling the partnership's business. Under the new standard, some level of participation could be acceptable (distinguishing from the passive investor test). The court remanded the case to the Tax Court to apply the new test. Note that this role-based analysis currently only applies in the Fifth Circuit, setting the stage for a potential split in the analysis over the Section 1402 exception. For more information on taxation of limited partners, visit Tax Facts Online. Read More: Link to Q7752.