A limited partnership agreement may identify someone as a limited partner. For federal self-employment tax purposes, that designation does not necessarily settle the question.
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 court held that the limited-partner exception under Internal Revenue Code (IRC) Section 1402(a)(13) (known as the SECA limited partner exclusion) requires more than limited liability under state law. A partner who runs, manages, or controls the partnership’s business does not qualify for the exception, even if the partnership documents call that person a limited partner.
The Second Circuit reached this result without adopting the Tax Court’s “generally akin to a passive investor” framing. Its test turns on management and control, not passivity.
For partnerships with active owners, the decision calls for a closer look at how each partner works in the business and how the partnership reports that partner’s share of income.
What the limited-partner exception covers
Partners generally include their share of partnership trade or business income in net earnings from self-employment. IRC Section 1402(a)(13) generally excludes a limited partner’s distributive share from net earnings from self-employment, but it does not exclude qualifying guaranteed payments for services.
That distinction can involve substantial amounts. Soroban’s three principals paid self-employment tax on their guaranteed payments. The dispute concerned approximately $141.5 million in distributive share of ordinary income allocated to them over two tax years, which the partnership had excluded from net earnings from self-employment.
What the court saw at Soroban
Soroban managed hedge fund investments and was classified as a partnership for US federal tax purposes. Its three principals held limited-partner interests, but they also worked full time in the business. They led investment and trading functions, served on governing committees, participated in personnel decisions, and exercised authority over the firm’s operations. The court concluded that their actual roles prevented them from qualifying as limited partners under the federal exception.
The ruling does not say that every service performed by a limited partner makes the partner subject to self-employment tax on a distributive share. The Second Circuit expressly recognized that a partner may provide some services or participate in the partnership without running, managing, or controlling it. The question is what authority the partner actually exercises.
Which partnerships should review their position?
The facts in Soroban involved an investment manager, but the issue can arise wherever active owners receive partnership income. Professional services firms, private equity and venture firms, real estate businesses, and other operating partnerships should examine positions that rely primarily on a partner’s state-law title.
The IRS has likewise indicated that the Section 1402(a)(13) exception turns on whether the partner qualifies as a limited partner for purposes of the federal self-employment tax rules. The current Form 1065 instructions do not provide a comprehensive functional test, however, so taxpayers should consider the partner’s actual rights, responsibilities, and involvement in the partnership’s business in light of the applicable case law.
A review is especially useful when a limited partner:
- directs operations or investment decisions;
- supervises employees or makes hiring and firing decisions;
- serves on a management committee;
- negotiates major contracts or controls budgets; or
- has authority over other managers or the general partner
The nature and extent of a partner’s services may also provide context for the analysis. The Second Circuit noted that the Soroban principals played an essential role in generating the partnership’s income, in addition to exercising managerial control. The decision, however, focused on the principals’ management and control of the business; it did not hold that generating substantial revenue, by itself, causes a partner to lose limited-partner status.
These are indicators to investigate, not an automatic checklist that determines the tax result. Capital contributions, allocation terms, guaranteed payments, and the source of partnership income also help explain the economic arrangement. Partnership agreements should be compared with decision-making authority in practice.
How the appeals court decisions fit together
The Second Circuit’s ruling is broadly consistent with the Fifth Circuit’s August 12, 2026 decision in K Alain L.L.L.P. v. Commissioner, although the courts articulated their tests somewhat differently. Rehearing, the Fifth Circuit withdrew its January 2026 opinion, which had tied “limited partner” status to state-law limited liability. It substituted a standard under which a limited partner is one who plays no significant role in managing or running the business, and it vacated the Tax Court’s decision and remanded for further proceedings. The Second Circuit observed that there appears to be little daylight between the Fifth Circuit’s standard and the Tax Court’s holding in Soroban.
Which court’s law applies?
The Second Circuit hears appeals from New York, Connecticut, and Vermont; the Fifth Circuit covers Texas, Louisiana, and Mississippi. Outside the Second and Fifth Circuits, the precise federal-law standard remains unsettled. Partnerships should therefore avoid assuming that one appellate decision settles every active partner’s position. The partner’s responsibilities, the applicable court, and the partnership’s records all warrant attention.
How Aura Advisors can help with limited partner self-employment tax
The practical starting point is a partner-by-partner review: who has authority, what work do they perform, how is income allocated, and how have those amounts been reported? That review may reveal a supportable existing position, a documentation gap, or a need to reconsider current and prior-year reporting.
Aura Advisors can help partnerships assess those facts against the developing case law, model potential exposure, and develop a defensible reporting approach that reflects how the business actually operates.
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