On August 13th, we provided an overview of the August 12th opinion issued by the 5th Circuit in Sirius Solutions (No. 24-60240) (now named K Alain, L.L.L.P.), in which the 5th Circuit reversed its January 16th opinion and remanded the case to the Tax Court under a newly announced standard as to who can qualify for the limited partner exclusion from self-employment tax contained in §1402(a)(13). The standard set by the 5th Circuit is that a limited partner “is a partner who plays no significant role in managing or running a business”; however, “some participation is allowed, so long as the partners do not exercise control over the business.” (Emphasis and plural in opinion.) In doing so, the 5th Circuit rejected the Soroban “passive investor” standard and its “functional analysis test,” with the 5th Circuit indicating that the Tax Court was in error in barring “even the most minor involvement” in the partnership’s affairs as disqualifying eligibility for the limited partner SE tax exclusion.

As we now have had a little over two weeks to think about this major case, some significant questions come to mind. It will be interesting to see if the Tax Court provides any guidance on remand, or if it will conclude, without any explanation, that the Sirius partners were so far “over the line” that they failed the 5th Circuit standard.

Some of these questions include:

1. What constitutes “significant participation”? It would not be surprising if the IRS were to apply its 500-hour standard contained in the §469 regulations and in its 1997 proposed regulations under §1402(a)(13) (which to date have not been withdrawn).
2. What constitutes control? Will control be limited to partners who have the right to bind the entity under state law?
3. Can an individual wear two hats, where the individual exercises any management or control function in a separate management entity for which reasonable guaranteed payments or allocations of income are made to provide reasonable “compensation” for the services rendered?
4. Will any services provided by a limited partner performed “wearing a different hat” through an affiliated management entity play a role in determining whether the individual “wearing his limited partner hat” has provided “too much” participation and/or is considered to manage/control the business?
5. Where there are multiple persons involved, can one person be designated as having control (i.e., the “guinea pig”) and all other persons have no management rights, but still provide significant services? Of course, the non-managing partners have to be willing to cede these rights. In this regard, what if the non-managing, but significantly participating, persons have veto rights over significant decisions?
6. How do the Sirius standards apply in the context of an LLC, although the language in the case implies that §1402(a)(13) standards would be applied to an LLC in the same manner as in the case of a limited partnership?

Needless to say, Sirius and the structuring considerations to maximize the SE tax exclusion will be a major topic of discussion at both of this year’s Tax Planning Forum® and Fundamentals of Flow-Through® programs. We hope that you will consider attending either or both of these virtual or in-person programs or our new Fundamentals QAS self-study program. Registration is in full swing, and we encourage you to register soon, especially if you are interested in either of our in-person programs in Las Vegas or Orlando where space is limited.