In the United States Court of Appeals for the Fifth Circuit in Sirius Solutions, LLLP; Sirius Solutions GP, LLC; Tax Matters Partner, v. Commissioner, (5th Cir. Jan. 16, 2026), the Fifth Circuit reversed the Tax Court and held that the term “limited partner” as used in IRC § 1402 (a)(13) means “a partner in a limited partnership that has limited liability” (emphasis added).
Background
To fund the Social Security benefits individuals, receive upon retirement, the federal tax code imposes a Social Security and Medicare tax upon every individual’s earnings. If you are a wage earner, approximately 7.65% of your earnings are imposed by withholding such taxes from your paycheck up to a certain maximum salary. For the tax year 2026, wages up to $184,500 are subject to a Social Security tax of 6.2%. However, for the Medicare tax of 1.45%, there is no limit and all wages are subject to the Medicare tax of 1.45%. Employers are required to match such taxes for the employee so that the combined taxes (for both employee and employer) for 2026 are 15.3% for wages up to $184,500 and for wages above such amount, the combined tax is 2.90% (1.45% for each employee and 1.45% for the employer) See IRC § 3101.
To complement the above taxes imposed on the wage earners, the Internal Revenue Code also imposes such taxes on the “the self-employment income of every individual” (the “SECA” tax) See IRC § 1401. Because a self-employed individual does not have an employer, he or she must pay twice the amount of the taxes on his or her self-employment income than a W-2 wage earner. Consequently, for the 2026 tax year, a self-employed individual would be subject to such taxes at the rate of 15.3% on the first $184,000 of earnings from self-employed income (12.2% for Social Security tax and 2.9% for Medicare tax) and 2.9% for all earnings in excess of $184,000 (for the Medicare tax only).
In the past few years, an important exception to SECA taxation is a limited partner’s distributive share of partnership income and its meaning of partnership income has been a hotly disputed topic. Thus, Section 1402(a)(13) of the Code provides in exception when computing a limited partner’s “distributive share of any item or loss of a limited partner, as such, which is excluded from the distributive share in determining such partner’s distributive share subject to self-employment taxes, other that guaranteed payments described in Section 707(c) for that partner for services actually rendered to or on behalf of the partnership to the extent that those payments are established to being the nature of remuneration for those services.”
In many limited partnerships, limited partners contribute capital funds to the partnership and generally do not provide any services. But what about limited partners who do provide substantial services to the partnership under the partnership agreement and do not allocate any or little amounts to such limited partners as guaranteed payments? Alternatively, what if three individuals form a limited partnership but contribute little if any capital to the business but are the three principal owners who contribute their services full time to the partnership business? Assume these three individuals also control the general partner of the limited partnership but such general partner only receives 1% of the partnership income whereas the three limited partners received approximately 99% of the partnership income. It would appear in these latter two scenarios that the exception provided by Section 1402(a)(13) can be a vehicle to avoid the imposition of SECA taxes (the Social Securities and Medicare Tax) in a manner not intended by Congress. In such situation, the U.S. Tax Court has determined that the exemption provided by Section 1402 (a) (13) required the court to make a functional analysis into the various roles and responsibilities of the partners and the fact that limited partners have limited liability is not determinative. See Soroban Capital Partnership LP v. Commissioner, 161 T.C. 310 (2023). In effect, the Tax Court ruled that the term “limited partners” refers to passive investors. Id. at 320.
Then in Sirius Solutions, L.L.L.P. v. Commissioner, 2026 WL 125600 (5th Cir. Jan. 16, 2026), the Fifth Circuit reversed the Tax Court which had followed its own Soroban passive investor test and held the term “limited partner” is a partner in a limited partnership that has limited liability. In so holding, the Fifth Circuit relied on the (A) text and (B) the Social Security Administration (“SSA”) and the IRS’s contemporaneous and longstanding interpretation of the term.
In focusing on the text, the Court of Appeals stated, “just as in any statute, it is to be given in ordinary meaning at the time of enactment”, I then consulted various dictionaries’ definitions at the time of the enactment of the current statute which was in 1977. In doing so, it found that the various dictionaries it examined confirmed that a key feature of a limited partner was limited liability. The Court of Appeals then turned to the agencies (the IRS and SSA) interpretation of the term stating that agency interpretations “issued contemporaneously with the statute….. and …. have remained consistent over time.” Idat. It then focused on the IRS partnership tax instructions starting in 1978 which defined “Limited Partner” as “one whose potential personal liability for partnerships debts is limited to the amount of money or the property contributed or is required to contribute to partnership”. According to the Court, this interpretation of limited partner remained consistent for well over 40 years. At no time did those instructions have a “passive investor” definition of the term limited partner.
The Court then stated it was not until 2022 that the IRS issued partnership tax instructions a bit differently. It added a caveat to its long-standing definition which stated as follows: “However, whether a partner qualifies as a limited partner for purposes of self-employment taxes depends upon whether the partner meet the definition of a limited partner under Section 1402 (a) (3).
The Court then found that the SSA’s contemporaneous and long-standing definition of “limited partner” in the Social Security Administration change made in 1977 matches the IRS definition contained in the partnership instructions.
The decision in Sirius is indeed important but no doubt it is not the final word on the meaning of “limited partner”. First of all , none of the other Circuit Court of Appeals have weighed in on this controversial issue. Consequently, the Tax Court “passive investor “test continues to be a current test in both the Eighth Circuit (for taxpayers in Missouri) and the Tenth Circuit (for taxpayers in Kansas) as neither circuit has ruled on this definition. Until they do, I expect the IRS to continue to apply the “passive investor “test and follow its decision in Soroban for taxpayers in Missouri and Kansas.