Those of you who were with us at one of our fall/winter Tax Planning Forum® programs are aware of our skepticism as to whether the adverse Tax Court decisions in Soroban Capital Partners, TC Memo 2025-52 (on appeal to the 2nd Circuit, Dkt. 25-1349), and Denham Capital, TC Memo 2024-114 (on appeal to the 1st Circuit, Dkt. 25-1349) (and implicitly in Sirius Consulting by reason of a procedural appeal to the 5th Circuit of the Soroban decision, Dkt. 24-60240), which denied the §1402(a)(13) limited partner exclusion from self-employment to “active” limited partners, would be upheld on appeal.
It turns out that our skepticism was warranted, at least in the 5th Circuit, as on Friday, the 5th Circuit, in a two-to-one decision, overturned the Tax Court denial of the §1402(a)(13) limited partner SE tax exclusion to the five Sirius limited partners who worked full-time in the partnership’s business. The various taxpayer and IRS arguments, and the 45-page 5th Circuit opinion, are too voluminous to be explored in detail in this email blast. However, essentially the 5th Circuit majority dispelled the Tax Court/IRS concept that a limited partner must be “passive” to qualify for the §1402(a)(13) exclusion or that a “functional analysis” must be made to determine whether a partner “really was a limited partner.” In this regard, the 5th Circuit’s analysis is quite amusing:
Third, consider the consequences of the IRS’s passive-investor interpretation. For over 40 years, it was easy for a limited partner in a state-law limited partnership to discern his tax liability and plan his affairs accordingly. But under the IRS’s new position, which requires the IRS to balance an infinite number of factors in performing its “functional analysis test,” Soroban, 161 T.C. at 319, how are thousands of limited partners across the country to determine ex ante what their tax liability will be? The short answer: Only with the help of an army of lawyers and accountants—and a whole lot of luck.
Moreover, the 5th Circuit made clear that the phrase “limited partner, as such,” contained in §1402(a)(13) is meant to distinguish between a limited partner’s allocable share of income and any guaranteed payments received as a general partner. Note, however, that the case did not delve into whether the guaranteed payments paid for services were reasonable for the services rendered, i.e., should some portion of the income allocable to the limited partners been recharacterized as having been made for services rendered? This may be a position that the IRS chooses to pursue another day.
Sirius certainly puts a smile on the face of taxpayers who work full-time and receive allocations of income in a limited partner capacity and claim the §1402(a)(13) SE tax exclusion (as well as non-managing LLC members under the rationale of the 5th Circuit, although not explicitly mentioned). However, as aptly noted in the Bloomberg report on the case:
The Tax Court is free to still apply its multi-factor test when judging the exemption claims of limited partnerships in other circuit court jurisdictions. But for state-law limited partners operating in the Fifth Circuit, the ruling could open a pathway to significantly reduce the risk of tax exposure.
We still await the decisions of the appellate courts in Soroban and Denham, although many tax professionals predict that those decisions will not be issued in the near future. (Coincidentally, the taxpayer’s reply brief in Denham also was released on Friday.) Will there be a split among the Circuits? Only time will tell.
2026 Programs Now Open for Registration
As announced on Friday, registration is now open for two virtual spring sessions of our newly updated Fundamentals of Flow-Through® program, along with our full 2026 schedule for both Fundamentals and Tax Planning Forum® programs. We encourage you to get a head start on registering, especially if you’re planning to attend one of our in-person programs in Las Vegas or Orlando.