Second Circuit Clarifies the Limited Partner Exception to Self-Employment Tax

Key Takeaway: Formal limited partner status is not enough. The Second Circuit affirmed the Tax Court’s functional analysis test, holding that a partner must have limited liability and must not run, manage, or control the partnership’s business to qualify for the exception in Section 1402(a)(13).

Background

On September 17, 2026, the U.S. Court of Appeals for the Second Circuit affirmed the Tax Court in Soroban Capital Partners LP v. Commissioner, the latest appellate decision addressing the scope of the “limited partner exception” from self-employment tax under Section 1402(a)(13) of the Internal Revenue Code. The court held that for this purpose a “limited partner” must have limited liability and must not run, manage, or otherwise exercise control or managerial authority over the partnership.

For background on earlier decisions, see our prior memoranda: Surely You Can’t Be Sirius, “Sirius-ly, Another Self-Employment Tax Ruling”, “Tax Court Delivers Coal to Another Limited Partnership Management Company”, and “For Fund Managers, Tax Court Ruling Sets Limited Partners Back, ‘As Such’”. Our Private Equity Law Report article on this topic, which may be behind a paywall, is available here.

The Second Circuit’s Decision

The court rejected the argument that state-law designation as a limited partner, standing alone, is sufficient for federal self-employment tax purposes. Looking to the ordinary meaning of “limited partner” when Congress enacted Section 1402(a)(13) in 1977, the court noted that the term historically encompassed two core characteristics: limited liability and the absence of managerial control. The phrase “as such,” the structure of Section 1402, and the provision’s legislative history reinforced that interpretation.

The result was straightforward on Soroban’s facts. The three principals were the founding limited partners of the investment manager and members of its general partner. They worked full time in the business, held senior management roles, managed investments, participated in personnel decisions, and served on all four of Soroban’s governing committees in 2016 and all but one in 2017. Based on their exercise of managerial control and significant role in generating Soroban’s income, the court therefore held that they were not “limited partners” within the meaning of Section 1402(a)(13), resulting in their distributive shares being subject to self-employment tax.

What the Decision Does, and Does Not, Resolve

The decision does not establish a bright-line test for determining when a partner “runs, manages, or controls” a partnership. It does, however, make clear that partners who comprise a partnership’s senior management and exercise substantial operational or governance authority are unlikely to qualify for the exception, regardless of their formal status under state law.

At the same time, the Second Circuit expressly recognized that a limited partner may provide some services to a partnership without necessarily losing the exception. The relevant question is not whether the partner performs any services, but whether the partner’s activities amount to controlling, managing, or running the business. This leaves room for fact-specific arguments for service providers who do not exercise managerial control, although the boundaries remain uncertain.

The Second Circuit also described its approach as largely consistent with the Fifth Circuit’s recently revised decision in K Alain (formerly Sirius Solutions) L.L.L.P. v. Commissioner, which stated that a limited partner is one who plays no significant role in managing or running the business. Although the formulations are not identical, the Second Circuit observed that there may be little practical daylight between them. That convergence may reduce the likelihood that the Supreme Court will view the issue as presenting a significant circuit conflict, particularly where the partners at issue plainly exercised significant management authority.

Practical Considerations

• Investment managers and other service partnerships should reassess open tax positions involving the limited partner exception, with particular attention to partners’ actual authority, governance roles, time commitments, and contributions to revenue generation.
• Partnership agreements, committee structures, titles, delegated authority, and day-to-day practices should be reviewed together. Formal labels are unlikely to carry the issue if operational facts show managerial control.
• New investment managers should evaluate the potential tax benefits and risks of limited partnership structures in light of the Second Circuit’s functional test and the expected roles of individual partners.

Final Remarks

Seward & Kissel LLP actively monitors tax developments and their impact on the investment management industry. For additional information regarding this decision, please contact a member of Seward & Kissel’s Tax Group.