Fifth Circuit Creates New Test for Limited Partner SE Tax
The court replaced its prior bright-line rule with a new, fact-intensive standard focused on whether a partner plays a significant role in managing or running the business.
In a substitute opinion for 'K Alain L.L.L.P. v. Commissioner', the U.S. Court of Appeals for the Fifth Circuit withdrew its January 2026 decision that had created a bright-line test for the limited partner exception to self-employment tax. The prior ruling held that a partner's status as a limited partner under state law was sufficient to qualify for the exception. The new opinion rejects that test, as well as the Tax Court’s stricter “passive investor” standard from 'Soroban v. Commissioner'.
Instead, the court adopted an intermediate, management-based standard, holding that the exception is for partners who play no “significant role in managing or running a business.” This creates considerable uncertainty for partnerships and their advisors, as the court did not define the threshold for a "significant role." The decision directly affects tax structuring and reporting for limited partnerships, particularly investment funds and service partnerships.
The case was remanded to the Tax Court to apply the new, undefined standard. With similar cases pending in the First and Second Circuits, law firms and their clients must now evaluate each limited partner's factual role and authority to assess their tax exposure, while watching for a potential circuit split that could prompt Supreme Court review.