The definition of “limited partner” for purposes of the self-employment tax exclusion hinges on a partner’s management and control activities, not a state law label, the 2nd U.S. Circuit Court of Appeals held. The decision comes a month after another circuit court pivoted on the meaning of limited partner. (Soroban Capital Partners LP v. Commissioner, 2026 WL 2751819, 9/17/2026)
Background
Individuals are generally subject to federal tax on their net earnings from self-employment, with proceeds used to fund Social Security and Medicare. However, IRC § 1402(a)(13) provides that limited partners may exclude their distributive share of income from a partnership from their self-employment net earnings.
Multiple circuit courts have been asked to weigh in on when a partner is a limited partner for purposes of this exclusion. The disputes have centered on whether individual partners are evading the tax by relying on state limited partner designations, while playing an active role in partnerships.
Court holds limited partner defined by lack of control
In a September 17 decision, the 2nd Circuit held that a limited partner is “a partner who, in addition to having limited liability, does not run, manage, or control the partnership’s business.” The court conducted a detailed textual and historical analysis of the statute to support this conclusion.
The 2nd Circuit emphasized that the “ordinary meaning” of limited partner when § 1402(a)(13) was enacted was a partner that had “both limited liability and limited involvement in managing the business.” The court rejected Soroban’s argument that a lack of control was not a key component in 1977 when the statute was passed into law.
And the government’s position on the tax carveout aligns with congressional intent, the court said. The exclusion was meant to apply for limited partners who earn income not from working, rather from investing.
The court was unpersuaded by Soroban’s argument that Congress would have explicitly defined a limited partner as a “passive investor” with no control if that was its intent in § 1402(a)(13). In 1977, the term limited partner was understood to mean a partner who functioned as a passive investor, the court explained, making the addition of “passive” redundant. “We do not require Congress to repeat itself several times over before we give its words effect,” reads the decision.
Decision comes after 5th Circuit changed course
The decision comes a month after the 5th Circuit pivoted on the meaning of limited partner for purposes of self-employment tax — withdrawing a January decision that interpreted limited partner simply as a partner with limited liability under state law. In a substitute decision, that court narrowed the application of the self-employment tax exclusion to limited partners with “no significant role in managing or running a business.” (K Alain LLLP v. Commissioner, 184 F.4th 766)
The 2nd Circuit referenced the 5th Circuit’s reissued decision in K Alain, noting that decision does not “expound on” the meaning of “non-significant role.” However, the 2nd Circuit said that “to the extent K Alain holds that a limited partner may provide some services to the partnership, we do not disagree.”
A limited partner can “play a role in the partnership” while qualifying for the exclusion, the 2nd Circuit explained. The key is that the services or activities cannot constitute control or management, the court added.
The 2nd Circuit also rejected the taxpayers’ argument that net earnings from self-employment is a non-partnership item, and inappropriate for adjustment in a partnership-level proceeding.
“The courts so far unanimously agree that the meaning of ‘limited partner’ is a matter of federal law and depends on the partner’s role in running the business, and not a formalistic test based on state-law,” said NYU Tax Law Center’s Julie Avetta. “Though courts have framed the test for limited partner somewhat differently, we agree with the Soroban court that there’s very little daylight between these holdings; the Tax Court, the Fifth Circuit, and now the Second Circuit have all interpreted section 1402(a)(13) consistent with Congressional intent to impose self-employment taxes on earnings from work.”
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