On September 17, 2026, the Second Circuit Court of Appeals issued its decision in Soroban Capital Partners LP v. Commissioner, affirming the Tax Court’s conclusion that the limited partner exception to self-employment tax under Section 1402(a)(13) is not determined solely by state-law limited partner status. The court held that a limited partner must not only have limited liability, but also must not run, manage or control the partnership’s business.
This speaks to both a substance and form interpretation where the role and legal structuring of a partner’s interest determine if limited partner status and self-employment tax are applicable.
In Soroban, the taxpayers argued that because their partnership interests were held as limited partnership interests under state law, the distributive share of profits allocated to the firm’s principals should qualify for the limited partner exclusion. The IRS disagreed, instead arguing that the partners actively managed the business and were subject to self-employment tax. The Second Circuit sided with the government.
Why This Matters for Alternative Asset Managers
In the alternative asset industry, management companies and entities receiving fees are often structured as a combination of Limited Partnerships (LPs) and Limited Liability Companies (LLCs). The LLC is set up as the general partner of the management company, which is a limited partnership. The LLC holds a small stake (often 1%) in the LP as a general partner, and both entities typically are owned by the same individuals. Those individuals are members of the LLC but claim limited partner status on their LP interests, which has resulted in significant self-employment tax savings that the IRS and Tax Court are contesting.
A Key Distinction in the Second Circuit’s Decision
While the court affirmed the Tax Court’s overall conclusion, it did not fully endorse a broad framework. The court acknowledged that a partner may perform some services for a partnership while still qualifying for the limited partner exception, provided those activities do not rise to the level of managing, controlling or running the business. This leaves room for partners to argue that their services do not rise to this standard.
What Happens Next
The Second Circuit’s ruling is another in a long line of litigation. On August 12, the Fifth Circuit withdrew and substituted its opinion in Sirius Solutions v. Commissioner (now proceeding as K Alain, L.L.L.P. v. Commissioner on rehearing). There is still a case pending in the First Circuit, and the possibility that any of the three active cases may be appealed to and heard by the Supreme Court.
Practical Considerations for Taxpayers and Advisors
Taxpayers who currently utilize this structure, or those considering it, should consult with their legal counsel and tax professionals to understand the risk inherent in the structure—as well as the potential savings it may offer. This ruling introduces some key nuances to the overall discussion but does not yet settle the debate.
Recent rulings from both the Fifth and Second Circuit suggest momentum for the IRS’ position that function is a key component of the limited partner exception, in addition to legal form.
Choosing this structure is a nuanced decision based on risk appetite, as well as facts and circumstances. The structure can provide savings; however, if contested by the IRS directly via a notice, a client must understand that significant time, money and resources might be needed down the road—especially if further court decisions (and potentially the Supreme Court) rule in the IRS’ favor.
Any partner utilizing this position should think both qualitatively and quantitatively about their role and time spent in the business to prepare ahead of time for any potential challenges. This can include preparing contemporaneous documentation of partner roles and economics before an examination occurs and assessing whether there is support for treating a portion of allocations as a return on invested capital rather than compensation for services performed.
Looking Ahead
More litigation is expected before a clear and consistent standard emerges. The Second Circuit’s decision has introduced a gray area much like the Fifth Circuit’s ruling before it.
Questions about how this evolving issue may affect your ownership structure or self-employment tax position? Contact a Grassi advisor to discuss the potential implications.
