Fifth Circuit Withdraws Favorable Sirius Self-Employment Tax Opinion and Issues an Unfavorable Opinion — Impact on Fund Managers

This alert briefly discusses the Fifth Circuit’s August 12, 2026 opinion in K Alain, L.L.L.P. v. Commissioner (the “Recent Opinion”). In the Recent Opinion, the Fifth Circuit withdrew its prior decision and issued a new decision generally affirming the IRS’s position in the case. The prior decision, which was favorable to the taxpayer, was issued in January 2026 under the case’s former name, Sirius Solutions, L.L.L.P. v. Commissioner (the “Prior Opinion”).

Section 1402(a)(13) of the Internal Revenue Code provides that the calculation of a limited partner’s net earnings subject to self-employment tax excludes the limited partner’s distributive share of partnership income or loss received “as such.” The taxpayer in this case argued that amounts received “as such” means received in the partner’s capacity as a state-law limited partner (as opposed to, for example, guaranteed payments for services). The IRS, on the other hand, argued that the exception applies only when the partner is a passive investor, regardless of state law designation.

The Prior Opinion held that a limited partner for purposes of Section 1402(a)(13) was a person who was a limited partner of a limited partnership and enjoyed limited liability under state law. The Prior Opinion rejected the IRS’s position that the limited partner exception applies only to passive investors. The IRS has prevailed on that position in two other Tax Court cases, Soroban Capital Partners and Denham Capital Management, both of which are currently on appeal.

The Recent Opinion ruled that the limited partner exception applies to “a partner who plays no significant role in managing or running a business” and focuses on managerial control. While this standard is more favorable than the passive-investor position in theory, in practice the distinction may be limited in the fund-management context because the limited partner exception is often relied upon by principals and others in senior roles.

It is too early to determine exactly how the Recent Opinion will affect the limited partner exception position. The Fifth Circuit remanded the case to the Tax Court for further proceedings under the new standard, and the appeals in Soroban and Denham remain pending in the Second and First Circuits, respectively. Other cases are also likely to arise in this area.

In the meantime, calendar-year partnership and individual tax returns for 2025 that are on extension generally are due on September 15 and October 15, 2026, respectively. The Recent Opinion may affect the positions that tax return preparers and taxpayers decide to take on their 2025 returns and, for taxpayers claiming the limited partner exception, whether protective disclosure on the return may be appropriate.

Managers should consult their tax counsel and tax return preparers to determine the potential impact, if any, of the Recent Opinion on their structure and tax returns in light of their specific facts. Managers that have previously utilized the limited partner exception, or which intended to do so for the 2025 tax year, will need to consider whether they should remain as limited partnerships or explore other structuring options. However, managers structured as limited partnerships do not necessarily need to restructure.

We will continue to monitor this issue, including its implications for managers with respect to prior-year positions and future-year reporting.

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If you have any questions regarding the above or any other tax issues, please contact your primary Kleinberg Kaplan attorney or one of the members of our Tax Practice.