ARTICLE | May 12, 2026
If you are a limited partner in a Texas-based business, a landmark federal court ruling issued in January 2026 could have a meaningful impact on how much self-employment tax you owe -- and how you should be thinking about your tax strategy going forward.
What the Court Decided
For years, the IRS argued that the self-employment tax exemption available to limited partners under Internal Revenue Code Section 1402(a)(13) applied only to "passive investors" -- those who took a purely hands-off role in the partnership. If you actively worked in or managed the business, the IRS's position was that you did not qualify as a "limited partner" for tax purposes and therefore owed self-employment tax on your share of partnership income. The Tax Court agreed with the IRS in a 2023 case (Soroban Capital Partners LP) and applied that same logic to overturn a Texas-based consulting firm's tax treatment in 2024.
In January 2026, the U.S. Court of Appeals for the Fifth Circuit reversed course in Sirius Solutions, LLLP v. Commissioner. In a 2-1 decision, the court held that a "limited partner" for purposes of the Section 1402(a)(13) exemption is simply a partner in a limited partnership who has limited liability -- period. The court rejected the IRS's passive-investor test, finding it unsupported by the statute's plain text, historical dictionary definitions, and more than 40 years of consistent guidance from both the IRS and the Social Security Administration. The court was blunt: "The passive investor interpretation is wrong."
"This is a significant win for limited partners in Texas and across the Fifth Circuit," said Lisa Smith, Senior Tax Manager at KHA Accountants. "For years, limited partners who were actively involved in their businesses faced real uncertainty about whether their distributive shares of partnership income were subject to self-employment tax. This ruling brings much-needed clarity and confirms what many tax professionals believed the law meant all along."
What This Means for Your Self-Employment Tax Planning
The practical implications of this ruling are significant. Self-employment tax currently runs at 15.3% on income up to the Social Security wage base, and 2.9% on income above it. For limited partners with substantial distributive shares of partnership income, the difference between owing and not owing self-employment tax on that income can amount to tens of thousands of dollars annually. Under the Fifth Circuit's ruling, limited partners in state-law limited partnerships with genuine limited liability can exclude their distributive shares of partnership income from self-employment income -- even if they actively work in the business. Note, however, that guaranteed payments received for services rendered to the partnership remain subject to self-employment tax under the law regardless of this ruling.
"The ruling is good news, but it is not a green light to stop paying attention," said Lisa Smith. "The law is still unsettled outside the Fifth Circuit, and there are pending appeals in the First and Second Circuits that could reach a different conclusion. Business owners need to work with their advisors to make sure their partnership structure is correctly set up under state law and that they are documenting limited liability status appropriately -- not just assuming the exemption applies."
Key Action Steps for Limited Partners
- Review your partnership structure. The Fifth Circuit's ruling applies specifically to state-law limited partnerships. If your business is structured as an LLC, LLP, or other entity type, the court's ruling does not directly address whether you qualify for the exemption. Talk to your advisor about whether your structure positions you to benefit.
- Confirm your limited liability status. The court made clear that the exemption depends on whether a partner actually has limited liability under state law -- not just what the partnership agreement calls them. Make sure your documentation supports this status.
- Assess open tax years. If you or your business filed returns that included self-employment tax on limited partner distributive shares for years under audit or still open under the statute of limitations, it may be worth discussing whether an amended return or other corrective action is appropriate.
- Monitor developments in other circuits. Appeals are currently pending in the First and Second Circuits on the same issue. If the circuits diverge, the Supreme Court may ultimately resolve the question. Stay informed and plan with that uncertainty in mind.
- Do not overlook guaranteed payments. Even under the Fifth Circuit's ruling, guaranteed payments you receive for services rendered to the partnership remain subject to self-employment tax. Make sure your compensation structure is accurately documented and properly classified.
How KHA Can Help
At KHA Accountants, we have spent more than 50 years helping Texas business owners navigate complex tax law changes with confidence. Whether you need a fresh look at your partnership structure, help assessing the impact of this ruling on your prior or current tax returns, or proactive planning to optimize your self-employment tax position, our experienced tax team is here to help.
Contact KHA Accountants today at www.kha.cpa to schedule a consultation with one of our tax advisors and make sure you are positioned to take full advantage of this important ruling.