The Limited Partner Self-Employment Tax Test

So, you sit as a limited partner on a deal you still run. The K-1 comes back with the LP box checked. Nobody picks up self-employment tax on the distributive share. That is the plan. It is also the plan the Fifth Circuit just sent back to Tax Court. They did not bless it.

K Alain, L.L.L.P. v. Commissioner, No. 24-60240 (5th Cir. Aug. 12, 2026), used to be called Sirius Solutions. It was a Houston consulting firm with offices in Dallas and London. From 2014 through 2016, the individual partners took all the ordinary income. The corporate general partner held 0.6457% in 2014 and 0.7529% after that. But the partnership reported $0 of net earnings from self-employment.

The IRS did not buy the label. In notices of final partnership administrative adjustment, the Service moved net earnings from self-employment from $0 to $5,915,918 for 2014. That is the number. 2015 went to $7,372,756. 2016 was already a loss.

This topic has been coming up consistently as late with Soraban, and many, many other cases out there (Denham, etc). It’s been a hot topic of courts for a while, and might finally see it’s Supreme Court purview (eventually). 

What is a Limited Partner?

“Limited partner” on the K-1 is not the self-employment tax test. After K Alain, the Fifth Circuit asks whether you play a significant role in managing or running the business, and that opinion withdrew its own January holding, vacated Tax Court, and remanded.

Now, what LPs of hedge funds have been trying to do for a very long time is state that, under state law, they have ‘limited liability’, they have no SE tax. 

This has been tried with other entities outside of Limited Partnerships and has ultimately failed due to Tax Courts’ ‘functional analysis’ which basically states, ‘if you have any kind of managerial control, you’re going to get hit with SE.’ The state law label is not good enough, and they have been consistent with this in Renkemeyer and Soraban.

This is for the working partner who thinks the LP box gets them out of SE tax.

What §1402(a)(13) actually carves out

Section 1402(a)(13) excludes from net earnings from self-employment “the distributive share of any item of income or loss of a limited partner, as such, other than guaranteed payments described in section 707(c).”

A limited partner’s distributive share can stay out of this calculation. Guaranteed payments for services stay in. Congress wrote that in 1977 as part of the Social Security Amendments of 1977, Public Law 95-216, and the statute still says it.

Also, updates were made in 1986 that somewhat closely resemble and align with Sec. 469 tests, but I would not entirely rely upon those. 

The fight is the federal meaning of “limited partner.”

Sirius treated the individual partners as limited partners and excluded their entire distributive share. The agreement said limited partners would not participate in management or control. The same agreement had a covenant not to take outside employment. The parties stipulated that each individual partner worked exclusively for the firm and devoted large amounts of time to it: delivering client work, developing the business, supervising staff, billing hours, selecting staff for engagements, negotiating those engagements, and participating in hiring, evaluating, and terminating people.

The general partner, Sirius Solutions GP, L.L.C., was owned by some of those same people. It held a tiny interest, took no fee, held no real board meetings, and provided nominal GP services. The partnership allocated none of the ordinary income to it.

If you can see here, the spirit does not seem to match the intention. 

Courts Flip-Flop

While the case sat in Tax Court, that court decided Soroban Capital Partners LP v. Commissioner, 161 T.C. 310 (2023). For purposes of §1402(a)(13), “limited partner” means a passive investor. That status is determined by a functional analysis of what the partner actually does, not the state-law title. After Soroban, the Sirius parties stipulated that under that test these partners were not limited partners. Sirius still said Soroban was wrong as a matter of law. They asked Tax Court for a decision against themselves so they could appeal. Tax Court entered it, upheld the IRS adjustments, and Sirius went to the Fifth Circuit.

On January 16, 2026, in Sirius Solutions, L.L.L.P. v. Commissioner, 165 F.4th 374 (5th Cir. 2026), the Fifth Circuit rejected Soroban. A limited partner, the court said then, is a partner in a state-law limited partnership who is afforded limited liability. Title plus the shield. The court vacated the Tax Court. This was a rather surprising decision, to be honest with you. But the IRS did not relent. 

The Commissioner asked for rehearing. On August 12, 2026, the panel withdrew that opinion and substituted K Alain. The new holding: the original public meaning of “limited partner,” as of 1977, is “a partner who plays no significant role in managing or running a business.” The court looked at dictionaries from around 1977, the Uniform Limited Partnership Act, and contemporaneous treatises. A 1977 reader would have understood that a limited partner could not manage the partnership, “but perhaps could participate in certain nonmanagerial aspects of the business.”

That is not the Tax Court’s “passive investor” line. And, it is also not the January “limited liability is enough” line. It is a managerial versus non-managerial distinction. Some participation could survive. But if you are running the shop, then it does not. 

Because Tax Court had measured these partners against Soroban’s passive-investor standard instead of this one, the Fifth Circuit vacated and remanded again. Tax Court has to look at the same people under the new test. The court did not decide whether these partners played a significant role. Judge Graves dissented. His view: they already stipulated to full-time client work, staff supervision, and hiring. Limited in name only, and that’s not good enough. 

I read the substituted opinion. And where the line sits is relatively grey. The court did not draw it. They said there will be a great deal of litigation about how much participation is too much. That is a facts fight, not a form-box fight.

Here is my take on this: it’s not entirely correct, but you have to view it as material participation in some ways. If you are spending maybe 100 hours or less in the business? I think you’re likely going to be viewed as a true LP, and not subject to self-employment tax. You’re not a manager; you’re not in the day-to-day. You’re just kind of it. That’s not enough, in my opinion 

The moment you begin to creep beyond 500 hours and get closer to that threshold? Now you’re putting yourself into that manager category, and you have no choice but to be subject to SE

However, this 5th Circuit ruling only applies if you’re in Texas, Louisiana, or Mississippi; the Tax Court still starts with Soroban. K Alain binds the Fifth Circuit.

When the LP Box Does Not Get You Out

This does not hold when you work the deal and call yourself limited. You sit as LP. You still take the lender calls, hire the property manager, vote the major decisions, or run leasing and investor reporting. Your spouse is on as LP and still does the work. Your GP is a tiny LLC you own; it does not get paid, and it never meets. That is the Sirius fact pattern with different letterhead. The August opinion did not bless it. It sent it back for a facts trial under a management test. Guaranteed payments are still SE income either way. And if you are not in the Fifth Circuit, you are still looking at Soroban’s passive-investor rule first.

This strategy is incredibly old by this point, but people try to do this with their own partnerships. 

Have a non-working spouse be a 99% owner, and then have a 1% operator. Except that also doesn’t work here. We see that strategy still come out (despite it being debunked years ago), and the same rules apply here. 

The IRS Can’t Get Its Cake and Eat It Too

Now, this is one item that the IRS can’t win with. If you were trying to take LP status and not be subject to SECA, you were subject to the net investment income tax (NIIT). It’s 3.8% that’s meant to mirror Medicare. 

This means NIIT needs to be turned off if SE is turned on. 

It’s not a massive move, but it’s an important distinction here. 

What To Do With This

Ask: who does the work, who signs the contracts, who hires, who sits on the decisions that run the business. Write that down before anyone recharacterizes a distributive share.

Then model the SE tax with guaranteed payments in, and with the distributive share in, before you change how the 2026 K-1 is prepared. Do not treat a remand as a holding that your label wins.

Confused? (Me too). And our team can help protect you from this. 

Schedule a discovery call today.