On January 16, 2026, the U.S. Court of Appeals for the Fifth Circuit issued a closely watched decision in Sirius Solutions, L.L.L.P. v. Commissioner (“Sirius”), vacating and remanding the Tax Court’s holding that certain state-law limited partners were subject to self-employment tax (SECA) on their distributive shares of ordinary business income.
The Fifth Circuit rejected the Tax Court’s “functional analysis” test which focused on whether purported limited partners were “passive investors” or instead “limited in name only.” It held that, for purposes of the SECA limited partner exception in Section 1402(a)(13), a “limited partner” means a partner in a state-law limited partnership who is afforded limited liability under state law. The Fifth Circuit therefore vacated the Tax Court’s decision and remanded the case for further proceedings consistent with that interpretation.
For private fund managers, particularly those with management entities organized as state-law limited partnerships or limited liability limited partnerships (LLLPs), Sirius may strengthen the argument that partners’ distributive shares of ordinary business income can qualify for the SECA limited partner exception based on limited liability status, without a separate “passive investor” inquiry.
However, Sirius is not a blanket approval of all management-company structures and is only binding in the Fifth Circuit. The decision focused on partners in a state-law limited partnership or LLLP and does not directly resolve how Section 1402(a)(13) applies to LLC members or other non-LP forms. In addition, because the court tied the analysis to whether a partner is “afforded limited liability,” private fund managers should confirm that limited liability status is preserved under their governing documents and applicable state-law requirements.
Sirius is the first clear appellate pushback against the Tax Court’s recent trend toward a “functional” test in this area. However, meaningful uncertainty remains as Soroban and related cases are pending in other appellate courts.
In light of Sirius, private fund managers may wish to proactively evaluate their current structures. Morrison Foerster’s Private Funds and Tax teams are available to discuss the implications of Sirius and the pending Soroban and Denham appeals for your management company and fund structures.