5th Circuit Revises Its Decision in Sirius

In a move that surprised many court watchers, the 5th Circuit withdrew its original opinion in Sirius Solutions LLLP v. Commissioner and issued a substituted opinion that again vacates the Tax Court’s decision but changes the test for the limited partner exception to self-employment tax under IRC Section 1402(a)(13). Unlike its original decision, which held that a “limited partner” was a partner with limited liability in a state-law limited partnership, the 5th Circuit now holds that a limited partner for purposes of Section 1402(a)(13) is a partner who plays no significant role in managing or running the business.

Crowe observation

The Aug. 12 decision rejects the court’s prior rule based solely on state-law limited partner status and the Tax Court’s more restrictive passive-investor standard.

Background

Section 1402 generally includes a partner’s distributive share of partnership trade or business income in net earnings from self-employment. Section 1402(a)(13), however, excludes the distributive share of a “limited partner, as such,” other than guaranteed payments under Section 707(c) for services actually rendered to or on behalf of the partnership.

Sirius Solutions, now known as K. Alain LLLP, is a Delaware limited liability limited partnership that operated a business consulting firm. For 2014 through 2016, Sirius allocated its ordinary business income or loss to its individual limited partners and reported no net earnings from self-employment with respect to those allocations. The IRS determined that the partners were not limited partners within the meaning of Section 1402(a)(13) and adjusted Sirius’ net earnings from self-employment accordingly.

The Tax Court upheld the adjustments based on the framework established in Soroban Capital Partners LP v. Commissioner, which held that state-law limited partner status does not by itself establish eligibility for Section 1402(a)(13). Under Soroban, a functional analysis is required to determine whether a partner is functioning as a limited partner, which the Tax Court describes broadly as a passive investor. Sirius appealed the Tax Court decision to the 5th Circuit.

Revised 5th Circuit opinion

Instead of granting a rehearing en banc, the three judges who originally decided the case treated the request as a request for a panel rehearing, withdrew its prior opinion, and substituted it with a new opinion concluding that a limited partner is an individual who does not play a significant role in managing or running the business. The new opinion continues to reject Soroban’s passive-investor standard.

The new opinion remands the case back to the Tax Court to determine whether each partner played a “significant role” in managing or running the business.

Crowe observation

The 5th Circuit did not define what it means to have a “significant role,” which leaves continued uncertainty regarding who is eligible for the limited partner exception.

Looking ahead

With the new standard in the substituted opinion, partnerships within the 5th Circuit that are, or are considering, relying on the Section 1402(a)(13) limited partner exception should evaluate partners’ management and operational responsibilities rather than relying solely on state-law titles or limited liability. Partnership agreements, voting and governance rights, committee authority, personnel and budget responsibilities, and authority over client, investment, or other business decisions could become important in determining whether a partner has a significant role in running the enterprise. However, uncertainty will continue to prevail as the litigation in this case and others continues. Partnerships and partners should consult their tax advisers to evaluate eligibility for the limited partner exception.