Fifth Circuit Reverses Tax Court on Limited Partner Self-Employment Tax in Sirius Solutions
A recent Fifth Circuit decision has put the partnership tax world on alert. In Sirius Solutions, the Fifth Circuit reversed a previous Tax Court ruling regarding the limited partner exception to self-employment tax. The court rejected the Tax Court’s earlier approach and sided with the IRS.
This case addressed a specific question: can individual partners exclude their distributive shares from net earnings under Section 1402(a)(13)? On January 16, 2026, the Fifth Circuit filed a published opinion that answers with a firm “no” for many active partners.
Details of the Sirius Solutions Case
The dispute focused on whether the partners in Sirius qualified as “limited partners.” The IRS argued they did not. Therefore, their ordinary business income was subject to self-employment tax.
This adjustment increased net earnings from zero to $5,915,918. While Sirius challenged this in Tax Court, the Fifth Circuit ultimately reversed the decision in favor of the IRS.
Why This Decision Matters
The limited partner exception often creates uncertainty for modern LLCs and LLPs. These entities do not always fit neatly into old partnership concepts.
When courts and the IRS disagree on the definition of a limited partner, the stakes are high. This decision determines whether owners owe Social Security and Medicare taxes on large amounts of income. The Fifth Circuit’s ruling now provides a narrower reading of this tax exception.
Findings of the Fifth Circuit
The court explained that self-employment tax generally applies to all net earnings. Partnership distributive shares are usually included unless a specific statutory exception exists.
In this case, the court held that Sirius’s partners did not meet the definition of limited partners “as such.” Consequently, they could not exclude their business income from self-employment tax.
Changing the Planning Conversation
Business owners can no longer rely on labels alone. It is not enough to look like a limited partner under state law. Instead, the federal tax standard and the actual role of the owners matter most.
This ruling does not mean every partner must pay self-employment tax. However, it does make aggressive tax assumptions much riskier. Partnership planning now requires a closer review if owners are active in the business.
Next Steps for Business Owners
If you treat your distributive shares as exempt from self-employment tax, you should revisit that position now. You must review your governing documents and your specific role in the company.
This review is vital for expats with cross-border businesses. Self-employment tax for Americans abroad is already complex due to foreign entity rules and FEIE requirements.
We can help you navigate these changes. Please visit our business tax preparation page or explore our expat business tax resources. For a deeper look at your specific situation, check our tax planning and advice section to ensure you remain compliant.
