Surely You Can’t Be Sirius?

In a surprising development, on August 12, 2026, the Fifth Circuit Court of Appeals (the “Court”) withdrew its January 16, 2026, ruling in favor of the taxpayer Sirius Solutions, L.L.L.P. v. Commissioner (the “January Ruling”) and issued a new ruling (the “New Ruling”) reaching the same conclusion but under different reasoning that is less favorable to taxpayers.

Investment managers and other types of businesses often benefit from self-employment tax optimization in limited partnership structures due to the limited partner exception, which generally provides that a “limited partner, as such” in a partnership is not subject to self-employment tax on its share of partnership income. The Internal Revenue Service (“IRS”) has scrutinized these structures, auditing many fund managers. These audits have resulted in settled tax liabilities, and several IRS assessments have been challenged in the U.S. Tax Court.

In the January Ruling, the Court held, quite simply, that a “limited partner” is a partner with limited liability in a limited partnership.  In the New Ruling, the Court held that a limited partner is “a partner who plays no significant role in managing or running a business.”  Interestingly, the same judges relied on the same legal authorities to come to a different decision on what it means to be a limited partner.  The case was remanded to the U.S. Tax Court for further proceedings consistent with the New Ruling.

While the Court rejected the IRS’s position and prior U.S. Tax Court rulings^[1] that apply a functional analysis, subjecting non-passive limited partners to self-employment tax on such income, the New Ruling greatly narrows the limited partner exception relative to the January Ruling.  Given that many limited partners in investment manager entities actively participate in management of the entities’ business, those limited partners may be disqualified from the limited partner exception under the New Ruling.

However, much remains uncertain about the practical application of the New Ruling, particularly regarding the precise meanings of a “significant role” and “managing” or “running” a business.  The limited partner exception may no longer be available for senior management but remain available for other service providers in the organization.  The governance structure contained in an entity’s partnership agreement could be important; for example, if there were a contractual distinction between a partner who manages the business and a partner who merely has veto rights over significant decisions.

Separate appeals remain pending in the First and Second Circuit Courts, which cover New York and the New England states, perhaps will provide more clarity.  In any event, limited partners should continue to exercise caution in determining whether to claim the limited partner exception from self-employment income and be aware that significant risk remains in light of the IRS’s position, the New Ruling and U.S. Tax Court decisions.

For further background on the prior cases, please see our earlier memoranda: here, here and here.  Our Private Equity Law Report article on this topic, which may be behind a paywall, is available: here.

Final Remarks

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