Recent federal court decisions are raising questions about how the IRS views limited partners for self-employment tax purposes, especially when they actively manage or operate a partnership. At the center of these decisions is whether an individual’s legal classification as a limited partner is sufficient to qualify for a self-employment tax exclusion or whether their actual responsibilities within the business must also be considered.

While recent rulings from the Second and Fifth Circuits have established different standards, both suggest that legal classification alone may not be enough.

Understanding the Limited Partner Exception

Under Internal Revenue Code Section 1402(a)(13), a limited partner’s distributive share of partnership income or loss is generally excluded from net earnings from self-employment, except for certain guaranteed payments for services.

However, the Internal Revenue Code does not specifically define a “limited partner” for this purpose, and the Treasury never finalized proposed regulations addressing the issue. As a result, courts have increasingly been asked to determine whether limited-partner status depends primarily on legal classification or the individual’s actual involvement in business operations.

How Recent Court Decisions Differ

Recent decisions from the U.S. Tax Court and federal appellate courts have established different approaches to determining who qualifies for the limited partner exception.

The Tax Court: In Soroban Capital Partners LP v. Commissioner, the Tax Court concluded that state-law limited-partner status alone does not establish eligibility for the exclusion. Instead, a functional analysis is required to determine whether the individual operates as a limited partner in practice. In a subsequent decision, the court found that three principals who worked full time in the business and exercised significant managerial authority did not qualify for the exclusion.

The Second Circuit: On September 17, 2026, the Second Circuit affirmed the Tax Court’s decisions in Soroban, establishing that a limited partner must have limited liability and must not run, manage, or control the partnership’s business. The court clarified that providing services or participating in certain business activities does not automatically disqualify an individual from the exclusion.

The Fifth Circuit: In an August 12, 2026, decision in K Alain, L.L.L.P. v. Commissioner, the Fifth Circuit adopted a standard that defines a limited partner as someone who plays no significant role in managing or running the business. The decision replaced an earlier opinion by the Fifth Circuit that focused primarily on limited liability under state law. However, the court did not establish precisely what constitutes a significant management role, leaving that question for further consideration.

Although the standards differ, the decisions share an important conclusion: Legal classification alone may not be enough to establish eligibility for the self-employment tax exclusion.

What These Decisions Mean for Partnerships

Management responsibilities, including executive authority, personnel decisions, and involvement in day-to-day operations, may influence whether a partner’s distributive share is subject to self-employment tax. However, providing services to a partnership does not automatically eliminate eligibility for the exclusion.

Partnerships should review their ownership arrangements, document partners’ management responsibilities, and evaluate whether previously reported income or current tax positions warrant reconsideration. These considerations may be especially important for investment funds, professional-service firms, family investment partnerships, and other businesses where limited partners actively participate in management.

Despite the recent rulings, several questions remain unresolved. The First Circuit has yet to decide Denham Capital Management LP v. Commissioner, and neither the Second nor Fifth Circuit has determined whether members of limited liability companies (LLCs) or partners in limited liability partnerships (LLPs) taxed as partnerships may qualify for the exclusion under these standards.

Reviewing Your Partnership’s Self-Employment Tax Position

As the legal landscape continues to develop, partnerships should review their self-employment tax positions, including those taken on their 2025 returns and related Schedules K-1, particularly when those positions relied on interpretations that have since changed. Evaluating partners’ management responsibilities and current reporting practices can help identify potential tax implications and determine whether adjustments are needed.

Contact your CRI advisor to discuss how these developments may affect your partnership’s self-employment tax obligations. With additional court decisions and guidance still possible, staying informed and taking a proactive approach can help partnerships make more confident tax decisions as the rules continue to evolve.