In a move that shocked many tax practitioners, the Fifth Circuit has withdrawn its January opinion in a closely watched partnership tax case. In its place is a significantly different interpretation of who qualifies as a “limited partner” for purposes of the self-employment tax exception.

Background and Procedure

In January, the U.S. Court of Appeals for the Fifth Circuit held in Sirius Solutions, L.L.L.P. v. Commissioner that the term “limited partner” under section 1402(a)(13) of the tax code meant a state-law limited partner with limited liability. Under that approach, what a partner actually did for the business did not determine whether the exception applied—that was a very different take from the IRS’s view.

On August 12, 2026, the court withdrew its January opinion in its entirety and issued a substitute opinion in the case (now captioned K Alain L.L.L.P. v. Commissioner). The court now holds that a limited partner for purposes of section 1402(a)(13) is a partner who plays “no significant role in managing or running a business.”

If the whole thing has you scratching your head, it’s because this is not what happens in most court cases. Procedurally, here’s what happened.

After that January ruling, the government asked for an en banc rehearing. That means it asked the Fifth Circuit to reconsider the January decision. En banc rehearing requires action by the eligible active judges of the circuit and is considered extraordinary.

The Fifth Circuit denied the request. But the original three-judge panel treated the en banc petition as also asking for panel rehearing. A panel rehearing asks the original three-judge appellate panel to reconsider its own decision because it allegedly overlooked or misapprehended a material point of law or fact.

Ordinarily, the Fifth Circuit requires separate petitions for panel and en banc rehearing. But here, the original panel granted rehearing, meaning that the judges who decided Sirius in January agreed to reconsider their own decision. On reconsideration, the panel withdrew the original opinion and substituted a new one.

It also vacated the Tax Court's decision and remanded for the Tax Court to determine whether the partners satisfy the new standard. That means that the Tax Court now has work to do.

The Tax Bits

Here’s what’s at stake. Generally, a partner's share of partnership trade or business income is included in net earnings from self-employment and subject to self-employment tax. But there’s an exception for “the distributive share of any item of income or loss of a limited partner, as such,” other than certain guaranteed payments for services under section 707(c).

For years, taxpayers and the IRS have disagreed over what Congress meant by a limited partner. The IRS has generally argued that the exception should not shelter earnings attributable to a partner’s services. The Tax Court adopted a version of that approach in a case currently pending in another circuit. In Soroban Capital Partners LP v. Commissioner, 161 T.C. 310 (2023), the court concluded that determining whether someone is a “limited partner, as such” requires looking beyond state-law status and considering whether the partner is functioning as a passive investor.

However, the Fifth Circuit rejected that approach in its original January opinion. There, the court treated a limited partner largely as a legal status. If a person was a partner in a state-law limited partnership and enjoyed limited liability, the court concluded, that person was a limited partner for purposes of section 1402(a)(13).

That produced a relatively straightforward rule: limited liability, rather than participation in the business, controlled. The substitute opinion takes a different approach.

The New Opinion

In the new opinion, the Court held that the meaning of limited partner under section 1402(a)(13) is “a partner who plays no significant role in managing or running a business.” The new opinion does not provide much guidance for determining when a management role becomes “significant,” instead leaving the Tax Court to apply the new test on remand.

The court still rejects the Tax Court’s “functional analysis” from Soroban, which focused on whether a partner was functioning as a passive investor. But the Fifth Circuit has also abandoned the bright-line limited-liability rule it adopted in January.

The Fifth Circuit focused on what the term “limited partner” would have meant when Congress enacted section 1402(a)(13) in 1977. Looking to contemporary legal dictionaries, partnership statutes, and treatises, the court concluded that the term historically described a partner who did not play a significant role in managing or running the partnership. That means limited liability, standing alone, is no longer enough.

But neither, according to the Fifth Circuit, is the Tax Court’s passive-investor test.

So, the new opinion does not offer a bright-line rule. Instead, the result looks much more like the kind of facts-and-circumstances inquiry familiar throughout tax law. That means facts bearing on a partner's role in managing or running the business may now matter. Simply providing services, however, does not necessarily answer the question—the court expressly rejected a rule that equates limited partner status with pure passivity.

What About Partners Wearing Two Hats?

The new standard also raises questions for partners who act in more than one capacity. A partner, for example, might hold both a general partner interest and a limited partner interest, participating in management through the former while receiving a distributive share through the latter. Section 1402(a)(13) excludes the distributive share of a “limited partner, as such,” and the Fifth Circuit does not explain how its new management-based test applies when the same person wears both hats.

Does significant management activity in one capacity prevent the exception from applying to income received in another? Or does the statutory phrase “as such” require those interests to be considered separately? For dual-capacity partners, that remains an open question.

What Happens Next?

A Fifth Circuit decision is binding precedent for federal courts within that circuit, which includes Louisiana, Mississippi, and Texas. Elsewhere, the broader dispute over section 1402(a)(13) remains unsettled.

In the First Circuit, Denham Capital Management LP v. Commissioner, was argued on February 5, 2026. That court has since requested supplemental briefing on a jurisdictional issue, which could allow it to dispose of the appeal without reaching the section 1402(a)(13) question.

In the Second Circuit, Soroban was argued on June 25, 2026. (The Fifth Circuit made clear that it disagrees with the underlying issues in Soroban.)

If another circuit adopts the Tax Court’s passive-investor approach—or otherwise reaches a result inconsistent with the Fifth Circuit—a trip to the Supreme Court is not out of the question.

For taxpayers, meanwhile, the takeaway from the Fifth Circuit is no longer the simple rule announced in January. Limited liability alone is not enough. But participation in the partnership does not automatically disqualify a partner, either. The question now is whether the partner plays a significant role in managing or running the business.