Partnerships have gotten some additional clarity from the courts regarding the application of self-employment tax (SE tax) to limited partners. In August 2026, in K Alain v. Commissioner, the 5th Circuit Court of Appeals issued the first appellate court case on the meaning of the limited partner exception to SE tax.
In January, the 5th Circuit issued a decision in Sirius Solutions that squarely rejected the IRS’ position and concluded that a limited partner is not subject to SE tax merely because they have limited liability under state law. The government asked the full panel of judges on the court to rehear the case. Last week, in dramatic fashion, the full panel of judges refused to rehear the case, but the original three judges agreed to rehear it. That resulted in a withdrawal of the original decision and the issuance of K Alain, which is a meaningfully different decision.
How does K Alain relate to Sirius? The taxpayer has since undergone a name change to K Alain, so the decision was recaptioned from Sirius Solutions v. Commissioner to K Alain v. Commissioner. The remainder of this article will reference Sirius Solutions when referring to the original decision and K Alain when referring to the new decision.
K Alain provides conceptual clarity and might create more room for limited partners to be involved in a partnership without incurring SE tax, relative to the Tax Court’s view of the issue. But the decision is narrower than Sirius Solutions, and it remains to be seen how the law the 5th Circuit concluded upon will be applied on remand to the Tax Court.
The issue: SE tax and the limited partner exception
The issue at the center of K Alain has to do with an exception to the general rule that SE tax is imposed on partnership income. The exception is for “limited partners, as such.” That key language isn’t defined in the law, leaving it open to interpretation.
Historically, there has been limited guidance in this area. In 1997, Treasury proposed regulations for determining eligibility for the limited partnership exception, but due to backlash from affected taxpayers, Congress intervened to prevent finalization of those regulations. The IRS informally has signaled to taxpayers that it won’t challenge positions based on the proposed regulations, but no further guidance has been provided by the IRS since that date.
Before K Alain, the only nonadministrative authority was the Tax Court’s interpretation. That interpretation has consistently been that the limited partner exception is only available to passive investors, and that a functional analysis should be performed to determine whether the partner is truly a passive investor. This view would cause limited partners who want to maintain a measure of involvement in the partnership’s business to be subject to SE tax.
The Tax Court has offered limited guidance on which kinds of activities go beyond a passive investor’s role. Notably, in 2017, the Tax Court ruled favorably for a minority LLC member who attended quarterly partner meetings but had no authority or involvement in day-to-day management. The Tax Court has also applied its view regardless of whether the entity is a limited partnership or other state law limited liability entities, like LLCs, PLLCs, or LLPs.
How K Alain departed from the Tax Court’s approach
The 5th Circuit in K Alain rejected and softened the Tax Court’s hard-line approach, finding the operative language, “limited partner, as such,” refers to limited partners who don’t play a “significant role” in managing or running the partnership’s business. The 5th Circuit understands the term “limited partner, as such” to be hallmarked by limited liability and a lack of significant business control. It criticized the Tax Court’s view that even a minimal amount of business involvement could sacrifice the exception.
Still, the 5th Circuit didn’t provide any specifics as to what it considered to be a “significant role.” Thus, the question of whether the limited partners in K Alain played a significant role in the management of the partnership has been left for the Tax Court to decide on remand. While it’s clear that the “significant role” threshold is much narrower than the Sirius Solutions January decision that it withdrew, it’s not yet clear how much of a gap there is between the Tax Court’s original “functional analysis” and the 5th Circuit’s “significant role” in management threshold.
Facts matter: Limited partner exception
The weight of the K Alain decision on any particular taxpayer depends not just on a taxpayer’s facts, but also on where the taxpayer is located. K Alain is a 5th Circuit case, meaning where facts line up with this ruling, it’s controlling authority on taxpayers that would litigate in the 5th Circuit (taxpayers in Texas, Louisiana, and Mississippi). However, given that the 5th Circuit didn’t provide any framework for determining what a “significant role” is or what types of entities it could apply to, there are still many remaining questions, even for taxpayers in the 5th Circuit.
For those outside the 5th Circuit, the Tax Court is still permitted to follow its own precedent. Even after K Alain, we can fully expect the Tax Court, and likely the IRS, to continue adhering to the perspective that the limited partner exception is reserved for passive investors who refrain from business involvement. However, even where K Alain is not binding authority, its rationale can still be cited as support for a taxpayer’s position on the SE tax limited partner exception. In addition, taxpayers also continue to litigate the issue and argue that the IRS, Tax Court, and the 5th Circuit all hold incorrect interpretations of the law.
What comes next
This is an emerging area of law that will continue to develop iteratively. As noted above, K Alain now goes back to the Tax Court to apply the “significant role” standard to K Alain’s facts. However, a published decision from the Tax Court is going to take quite some time, and two others appeals from the Tax Court are pending: Denham Capital in the 1st Circuit, and Soroban in the 2nd Circuit. Decisions in each of those cases are likely to come long before we hear from the Tax Court again.
Based on oral arguments, the 1st and 2nd Circuits seem to be more supportive of the Tax Court’s point of view, but each of those courts are also entertaining the question of whether the IRS followed the proper procedure for addressing SE tax, which wasn’t an issue that was put in front of the 5th Circuit in K Alain. So, the 1st and 2nd Circuits could conclude (1) that the Tax Court’s approach is proper, (2) that the 5th Circuit’s standard is appropriate, (3) that a limited partner should be based solely on limited liability, (4) apply a whole new standard that hasn’t been put forth yet, or (5) avoid the issue by concluding that SE tax can’t be addressed at the partnership level.
So, what should a taxpayer do now? At each point along the way, as these cases make their way through litigation, taxpayers affected by these issues should consider if they impact the tax positions they are taking.
Key takeaways
- K Alain is a notable development in an uncertain area.
- While the decision is more favorable than the various Tax Court decisions (including the original Sirius Solutions decision), it’s still less favorable than the arguments taken by many taxpayers.
- With the coming decisions in the 1st and 2nd Circuits, the law will continue to develop.
- Taxpayers should continue to evaluate their position on SE tax exceptions in light of recent and future guidance.
