Several long-awaited court decisions clarifying the meaning of the exception to self-employment tax (SE tax) for limited partners have been issued in the past two months. The exception is available under Section 1402(a)(13) for “limited partners, as such,” and taxpayers have waited to see how three major cases would play out on appeal. In the first of these three cases, decided just last month, the 5th Circuit held in K Alain that the exception is open to limited partners under state law who “do not play a significant role in managing or running” the partnership. K Alain was a substituted, recaptioned opinion (formerly named Sirius Solutions).
The 2nd Circuit last week issued its own opinion in Soroban Capital Partners LP v. Commissioner. Soroban answered the question similarly to K Alain, holding the term means a partner who, in addition to having limited liability, “does not run, manage, or control the partnership's business.”
With Soroban and K Alain now decided, the law is beginning to settle around the idea that a limited partner, within the meaning of the SE tax exception, has two defining features. The first of these is limited liability, and the second is the lack of managerial control in the business.
While Soroban and K Alain use different terms to capture what it means to manage or run a business, both cases are aligned on the idea that limited partners can provide some services to the partnership without sacrificing the exception to SE tax. The exact measure of those services remains unclear and, under both cases, should largely depend on facts.
The current state of play
We still don’t have much of a feeling for how the new standards in Soroban and K Alain will translate into practical application. Soroban included a footnote indicating the two standards seem to have “little daylight” between them, especially insofar as they imagine a “limited partner, as such” to act in a way “generally akin” to a passive investor.
K Alain is now on remand in the Tax Court, meaning the Tax Court will now be required to apply the 5th Circuit’s “no significant role” standard to K Alain’s facts. When that case is decided by the Tax Court, we’ll likely learn more about how the K Alain standard differs from the Tax Court’s historic “functional analysis” and whether the Tax Court will continue with its approach outside of the 2nd and 5th Circuits.
As for the rule from Soroban, the 2nd Circuit did apply it to presented facts, but in an undemanding, straightforward way. The limited partners in Soroban worked approximately 2,500 hours in the business where they were involved in investment decisions, sat on governing committees, had analysts reporting to them, and played a part in decisions to hire, fire, and evaluate workers. The 2nd Circuit had little difficulty concluding on these facts that the partners didn’t qualify for the exception.
What to expect next from the courts: Denham and possible Supreme Court review
The partners in Soroban could ask the 2nd Circuit to rehear the case, but it seems more likely that the taxpayer will ask the Supreme Court for review. As things stand, however, it’s likely the Supreme Court wouldn’t grant review, if only because it seems the 2nd and 5th Circuits don’t differ tremendously in how they see the issue, and because Supreme Court review is exceedingly rare.
Still, all of this could get complicated by Denham. Denham is the third of the three major limited partner exception cases, as noted above, and is still pending in the 1st Circuit. The court heard oral arguments back in February, and Denham is likely the next substantive court decision that will be issued on this topic. Where the 1st Circuit lands on its views, and when it will issue its decision, will have some influence on how other cases progress.
The role of Treasury and the IRS
Until that time, the question that will be top of mind for many is, “Where is the government in all of this?” The IRS has continued to argue its position, consistent with the Tax Court’s understanding, that a functional analysis is appropriate. The IRS will no doubt consider Soroban a win, and the agency can be expected to continue pushing its position that the exception is reserved for passive investors, whatever that might mean in practice. These arguments have spanned each of President Trump’s administrations, so there’s no indication that the IRS or Treasury intends to pull back.
This, then, begs the question of whether the IRS and Treasury will issue further guidance. At this point, there are no final regulations. Proposed regulations from the 1990s would’ve adopted a functional approach, but Congress quickly issued a temporary moratorium barring the regulations from being finalized. Nothing has been finalized even since that moratorium expired.
The proposed regulations from the 1990s would have closed the “limited partner” exception to partners (1) who have power to contract for the partnership, or (2) who work more than 500 hours in the business. As to this first point, it’s unclear from K Alain and Soroban what courts would do in a situation where a partner may have the authority to bind the partnership, but who doesn’t actually exercise that authority in a meaningful, regular way. As to the second point, there is precedent for a 500-hour rule being relevant in the passive activity loss rules under Section 469, but it’s unclear whether a court would look more to the substance of the work done rather than the quantity, or whether both of those would be relevant factors.
So, will the IRS and Treasury issue regulations and, if so, when? The answers to these questions may also prove elusive. The IRS Priority Guidance Plan (PGP), which presents Treasury’s rulemaking agenda in laundry list form, currently doesn’t include this issue. This item was removed from the PGP issued in Sept. 30, 2025, despite the issue being included in the previous year’s PGP (the previous PGP was issued October 2024, just prior to the start of the current Trump administration). However, the most recent PGP was intentionally trimmed down in an attempt to reflect only the projects that would likely actually get accomplished by the end of the government’s fiscal year, so it wasn’t necessarily meant to reflect longer-term priorities. If recent history is any guide, the next agenda will be issued around the beginning of the next government fiscal year, which starts October 1.
But even if the exception is included in the coming PGP, we can expect additional drag on the rulemaking process. The Loper Bright decision means that the IRS and Treasury will need to toe a fine line of turning the several court decisions into a framework that will be respected by all courts going forward. Practically, this takes longer to make regulations, and there are persistent headcount and payroll difficulties at Treasury and the IRS that show no immediate signs of abating.
What to do now
This broader context should assure taxpayers that there’s plenty more to be learned and done before the dust fully settles on the true nature and scope of the exception to SE tax for limited partners.
However, with Soroban representing a significant step toward real clarity, it’s probably the right time for all tax partnerships to revisit their positions around SE tax and think about how the existing court decisions and possible future developments could have on those positions.
