Limited Partners and Self Employment Tax After the Fifth Circuit Ruling
Overview
A recent Fifth Circuit decision has significantly altered the federal self employment tax analysis for limited partners. In Sirius Solutions, L.L.L.P. v. Commissioner, the court rejected the IRS long standing functional analysis under IRC Section 1402(a)(13) and held that limited partner status is determined by legal form under state law, not by the level of participation in the partnership’s business. For taxpayers who are true limited partners, this ruling restores the statutory exclusion from self employment tax for distributive shares of partnership income, subject to limited and well defined exceptions.
For a deeper technical discussion of the case itself and its statutory analysis, see Sirius Solutions and Self Employment Tax for Partnerships .
What the Court Decided
The Fifth Circuit focused on the statutory language of Section 1402(a)(13), which excludes the distributive share of a limited partner, as such, from net earnings from self employment. The court concluded that Congress intended the term limited partner to carry its historical and legal meaning. A partner who enjoys limited liability under state law qualifies for the exclusion, regardless of whether that partner provides services or materially participates in the business.
In doing so, the court expressly rejected the Tax Court’s reliance on a functional or facts and circumstances test. The statute does not impose a participation requirement, and the court declined to rewrite the law based on policy arguments or legislative history. The decision vacated the Tax Court ruling and remanded the case for recomputation under this interpretation.
What Still Remains Subject to Self Employment Tax
The ruling does not eliminate self employment tax in all cases involving limited partners. Guaranteed payments for services remain fully taxable. Payments made under IRC Section 707(c) continue to be included in net earnings from self employment, even when paid to a limited partner who otherwise qualifies for the exclusion.
Practical Guidance for Limited Partners
- Confirm legal status. Review the partnership agreement and applicable state law to confirm that the individual is a limited partner with limited liability protection. This includes limited partnerships and limited liability limited partnerships with an entity serving as the general partner.
- Segregate compensation. Clearly distinguish guaranteed payments for services from distributive shares in both the partnership agreement and Schedule K 1 reporting.
- Evaluate disclosure. Outside the Fifth Circuit, consider protective disclosure on Form 8275 when relying on this decision in the face of contrary Tax Court precedent.
- Review refund opportunities. Taxpayers within the Fifth Circuit may have protective refund claims for open years where self employment tax was paid on limited partner distributive shares.
A broader planning focused discussion of limited partner self employment tax exposure is available in Limited Partner Self Employment Tax Explained .
Does Location Matter
Geography is critical. Within Texas, Louisiana, and Mississippi, the Fifth Circuit decision is binding. The IRS must apply this interpretation for taxpayers who reside or litigate in those states. Outside the Fifth Circuit, the IRS is expected to continue asserting the functional analysis endorsed by prior Tax Court cases, and the Tax Court may continue to follow its own precedent until another circuit or the Supreme Court resolves the split.
Even so, the decision provides substantial authority for return positions nationwide. Careful drafting, clear reporting, and strategic disclosure are now central to managing risk in this area.
See current federal rates on the Economic Dashboard .
Key Takeaway
The Fifth Circuit has returned the limited partner exclusion to its statutory foundation. Legal status now controls self employment tax treatment, not a subjective assessment of participation. Until Treasury issues final regulations or higher courts resolve the conflict, limited partners and partnerships should treat geography, disclosure, and agreement drafting as essential planning variables.
