Limited Partners Means Limited Partners
Fifth Circuit Ruling on Self-Employment Taxes: What Fund Managers Should Know
A recent Fifth Circuit court decision (the Sirius Solutions case) provided important clarification on how self-employment tax applies to limited partners. Historically, there has been uncertainty over whether partners who are actively involved in management—but hold limited liability interests—must pay self-employment tax on their share of partnership income.
In Sirius Solutions, the court ruled that state law classification carries more weight than activity level, offering meaningful guidance for certain fund and management company structures. However, this decision exists alongside other industry cases, most notably Soroban Capital Management, where the U.S. Tax Court found in favor of the IRS.
Why this matters to you:
- Limited partners under state law may be exempt from self-employment tax on distributive shares.
- Guaranteed payments for services remain subject to self-employment tax.
- General partners remain subject to self-employment tax.
- These rules materially affect management company economics and compensation design.
The contrast between these cases underscores that outcomes remain highly fact-specific. While Sirius Solutions offers a favorable perspective for those in the Fifth Circuit, the IRS continues to emphasize economic reality and service activity elsewhere. Managers should reassess their entity structures and partner classifications carefully.
If you’d like to discuss how these cases may apply to your specific structure:
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