On September 17, 2026, the U.S. Court of Appeals for the Second Circuit issued its opinion in Soroban Capital Partners LP v. Commissioner of Internal Revenue, affirming the Tax Court’s decisions and holding that a “limited partner” under Section 1402(a)(13) is one who both 1) has limited liability and 2) does not run, manage, or otherwise exert control or managerial authority over the partnership.1 This decision, as well as the Fifth Circuit’s revised opinion in Alain v. Commissioner, represent significant losses for taxpayers although the decisions applied slightly different standards for determining who is a “limited partner” for this purpose.2
The limited partner exception
The Internal Revenue Code (the “Code”) imposes self-employment tax on individuals’ net earnings from self-employment, which broadly defined includes most income from the active conduct of a trade or business.3 For this purpose, a partner’s distributive share of partnership income is generally subject to self-employment tax, unless an exception applies.4
At issue in Soroban is an exception that excludes “the distributive share of any item of income or loss of a limited partner, as such”, apart from guaranteed payments to the partner for services actually rendered by the partner to the partnership.5 Notably, the Code does not define what constitutes a “limited partner, as such” for purposes of this exception.
Before the Second Circuit’s decision, the U.S. Tax Court had held in Soroban that only partners who are passive investors qualify for the limited partner exception.6 In a subsequent decision applying that approach, the Tax Court concluded that principals who managed investments, made key business decisions, and exercised control over hiring and firm operations were limited partners in name only and could not qualify for the exception.7
How the Second Circuit reached its decision
The Second Circuit affirmed the U.S. Tax Court’s opinion and held that, for purposes of Section 1402(a)(13), a “limited partner” is one who has limited liability and who does not run, manage, or control the partnership’s business.8 In explaining its holding, the Second Circuit relied on three factors: 1) the text and structure of Section 1402 and its ordinary meaning, 2) the surrounding text and structure of Section 1402, and 3) the legislative history and historical context of Section 14029.
The Second Circuit rejected Soroban’s argument that “limited partner” means only a state-law limited partner with limited liability. In the Second Circuit’s view, federal tax law looks to economic realities rather than formal labels, and a partner who takes part in controlling the business is no longer acting as a traditional limited partner even if state law continues to use that title.10 The Second Circuit also acknowledged that a limited partner may provide some services to the partnership: “So long as the activities in question do not constitute controlling, managing, or running the business, a partner may play a role in the partnership and still qualify as limited.”11
A developing Circuit split
This decision comes shortly after the Fifth Circuit revised appellate decision in Alain v. Commissioner and creates a circuit split. The Fifth Circuit originally issued an opinion in Sirius Solutions, L.L.L.P. v. Commissioner on January 16, 2026, but withdrew its opinion and issued a revised opinion on August 12, 2026, under the recaptioned name “K Alain, L.L.L.P. v. Commissioner”. The Fifth Circuit’s revised Alain test asked whether a partner plays a “significant role” in managing or running the business, leaving room for some management participation so long as it is not significant. The Second Circuit’s test—whether the partner runs, manages, or exerts control or managerial authority—is stricter. The First Circuit has yet to release its decision in Denham Capital v. Commissioner, in which the same questions are at issue, and could add a third perspective.12
The Alain opinion states that the “original public meaning” of “limited partner” is “a partner who plays no significant role in managing or running a business.”13 In this shift away from a liability-based approach to one based on managerial role, the Fifth Circuit differs from Soroban’s “passive investor” standard, but adopts a middle position: some participation in management and business affairs may be permissible, so long as it is not “significant.”14
In issuing its opinion, the Fifth Circuit relied on 1) the 1916 Uniform Limited Partnership Act, and its 1976 revised form; 2) contemporaneous treatises describing the role of limited partners in management; and 3) First Circuit precedent.15 In summation of all sources considered, the Fifth Circuit expressed that all sources point to the same rationale: a limited partner is such because of their limited role in managing or running the business of the partnership.16
The Fifth Circuit remanded Alain to the Tax Court for further proceedings consistent with its ruling. The factual inquiry left by that decision remains important for fund managers assessing whether their principals’ involvement is significant.
Key considerations for fund managers
Many fund management companies are structured in a manner that enables all or a majority of the ownership of the fund principals in such management companies to be held by them as limited partners, notwithstanding the fact that they also own interests as general partners. Through such structures, they have claimed that the majority of income that the fund principals earn from the management company is not subject to self-employment tax.
After Soroban and K Alain, the exemption is not guaranteed simply because a person is a state-law limited partner with limited liability. Under the Second Circuit’s test, a principal who runs, manages, or controls the business will not qualify, even if the partnership agreement or state law continues to use a “limited partner” interest. The Fifth Circuit’s “no significant role” test may afford slightly more room than the Second Circuit’s test, but both decisions make clear that the analysis turns on the partner’s actual role. Fund managers should review their governance rights, operating roles, and management responsibilities in light of both standards and potentially consider the use of S corporations as an alternative to limited partnerships and limited liability companies.
What comes next
The First Circuit’s forthcoming decision in Denham Capital will be significant. If it adds a third perspective to the developing split, Supreme Court review would become more likely. In the interim, partners who claim the limited partner exception but materially participate in the applicable trade or business can expect IRS challenges.17
Footnotes
1 Soroban Capital Partners LP v. Comm'r, No. 25-2079, slip op. at 5-6, 30-42, 56-59 (2d Cir. Sept. 17, 2026), aff’g Soroban Capital Partners LP v. Comm'r, 161 T.C. 310 (2023).
2 See Alain v. Comm'r, No. 24-60240, 2026 BL 307549 (5th Cir. Aug. 12, 2026) [hereinafter Alain] (withdrawing and replacing Sirius Solutions, L.L.L.P. v. Comm'r, 165 F.4th 374 (5th Cir. Jan. 16, 2026)).
3 I.R.C. § 1401(a).
4 I.R.C. § 1402(a).
5 See I.R.C. § 1402(a)(13).
6 See Soroban Capital Partners LP v. Comm'r, 161 T.C. 310 (2023).
7 See Soroban Capital Partners LP v. Comm'r, T.C. Memo. 2025-52 (May 28, 2025).
8 See Soroban Capital Partners LP v. Comm'r, No. 25-2079, slip op. at 30.
9 Id.
10 Id. at 38.
11 Id. at 56-59.
12 See Denham Capital Mgmt. LP v. Comm'r, T.C. Memo. 2024-114 (Dec. 23, 2024), appeal pending, No. 25-1349 (1st Cir.).
13 See Alain, 2026 BL 307549, at 1.
14 Id. at 1.
15 Id. at 4-5.
16 Id.
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