Appeals Court Addresses Self-Employment Tax for Limited Partners

 Posted on January 19, 2026 in Employment Taxes

The tax laws in the United States change regularly, often because of court rulings that may determine who is subject to certain taxes or what exceptions may be available. Keeping track of these changes can be difficult, especially when rulings may only apply to people in certain areas of the country. One recent ruling by the Fifth Circuit Court of Appeals could affect some taxpayers who pay self-employment taxes, but questions remain about who will be affected or how subsequent rulings may change the tax landscape.

To stay on top of changes to tax laws, it is a good idea to consult with a tax lawyer. Individual taxpayers and businesses can receive guidance to help them understand how certain laws and court rulings will apply to them. Legal representation can also be beneficial when dealing with the IRS, either during tax audits or when resolving disputes in tax court or other venues.

Fifth Circuit Court of Appeals Addresses Self-Employment Tax Exemptions

Self-employment taxes (also known as SECA taxes) generally apply to business owners or other people who work for themselves. These taxes are similar to the Social Security and Medicare taxes that apply to employees. However, they can be deducted from a person’s gross income when calculating income tax.

For the last several decades, taxpayers who are classified as limited partners have been able to claim exceptions to SECA taxes based on Section 1402(a)(13) of the Internal Revenue Code. However, in recent years, the IRS has challenged this interpretation of Section 1402(a)(13), claiming that it only applies to passive limited partners. The IRS has claimed that limited partners who play an active role in a business do not qualify for the exclusion and are subject to self-employment taxes.

The U.S. Tax Court has sided with the IRS on this subject in multiple cases. It has found that active limited partners do not qualify for the exception to self-employment taxes, and an analysis may need to be performed to determine whether a limited partner is active or passive.

A recent ruling by the Fifth Circuit Court of Appeals took the opposite approach. In the case of Sirius Solutions LLLP v. Commissioner, the court stated that there is no distinction between limited partners who are active or passive. Based on the definitions used when the law was put in place in 1977, a limited partner is any partner in a limited partnership who has limited liability. Thus, any partner who is considered to be a limited partner will qualify for the exception to the self-employment tax.

For now, this ruling will only apply to taxpayers in the states within the Fifth Circuit: Texas, Louisiana, and Mississippi. Other appellate courts are expected to issue rulings on similar cases in the near future. If these rulings differ from the Fifth Circuit’s findings, the decision could be appealed by the IRS, and the ultimate ruling on the issue may be made by the U.S. Supreme Court.

Based on current laws and rulings by different courts, business partners may need to determine whether they qualify for an exception to SECA taxes. Even in the Fifth Circuit, the limited partner exception will only apply to people who are classified as limited partners in a business that is structured as a limited partnership. The exception generally does not apply to LLCs or entities other than limited partnerships. In cases where state laws remove limited liability based on factors such as a partner’s level of control, the exception may no longer apply.

Contact Our San Jose Business Tax Lawyer

Because the rules related to exceptions from self-employment taxes can be complicated, and they may be affected by new court rulings, business partners who are unsure about these issues may want to consult with a lawyer who understands the intricacies involved in tax-related issues. At John D. Teter Law Offices, our San Jose, CA tax attorney can provide guidance to business owners and partners on these matters. We can also provide representation during audits or tax appeals, working to protect our clients’ interests and help them mitigate penalties while minimizing the taxes they will be required to pay. Contact us today at 408-866-1810 to schedule a consultation.