Fifth Circuit Rejects Tax Court’s “Functional Analysis” Test in Sirius Solutions​

On Friday, January 16, 2026, the U.S. Court of Appeals for the Fifth Circuit issued a landmark decision that fundamentally disrupts the IRS’s recent campaign to limit the § 1402(a)(13) self-employment tax exception. In Sirius Solutions L.L.L.P. v. Commissioner, No. 24-60240, slip op. (5th Cir. Jan. 16, 2026), the Fifth Circuit vacated the Tax Court's ruling and held that the statutory term “limited partner” is defined by state-law limited liability status, effectively overruling the Tax Court’s “functional analysis” test within the Circuit for state-law limited partnerships.  

I. Background: The Rise of the Functional Analysis 

In the past few years, the Tax Court has moved toward a “functional” definition of limited partner status, most notably in Soroban Capital Partners LP v. Commissioner (2023) and Denham Capital Management LP v. Commissioner (2024). Under this regime, the Tax Court ignored state-law titles and applied a multi-factor test to determine if a partner was “generally akin” to a passive investor. If a limited partner was “active”, that is to say managing portfolios, supervising staff, or making investment decisions, the Tax Court held the partner was a “limited partner in name only” and therefore ineligible for the SECA exception.     

II. The Fifth Circuit’s Rejection of Soroban 

The Fifth Circuit’s opinion represents a return to strict textualism, rejecting the “passive investor” requirement on three primary technical grounds.  

1. The “Ordinary Meaning” and Statutory Silence: The Court held that because the Code does not define “limited partner,” it must be given its ordinary meaning at the time of enactment in 1977. Consulting contemporaneous dictionaries (e.g., Webster’s Third, Black’s Law Dictionary), the Court found the defining characteristic was limited liability, not a lack of participation in management. Crucially, the Court noted that when Congress wants to distinguish between “active” and “passive” participants, it knows how to do so (citing the “passive investment income” language in the Subchapter S Revision Act of 1982 and the “no services” requirement in § 1402(a)(10)).
2. The “Guaranteed Payments” Clause as Evidence of Activity: The Courtidentifieda structural flaw in the Tax Court’s reasoning: the “guaranteed payments” carve-out in § 1402(a)(13). The statute excludes a limited partner's distributive share other than guaranteed payments for “services actually rendered”. The Fifth Circuit reasoned that if the statute already expects limited partners to receive payments for services, Congress clearly contemplated that limited partners could be active. A strict “passive-investor” test would render this entire clause superfluous. 
3. Dismantling the "As Such" Argument: In Soroban, the Tax Court leaned heavily on the phrase “limited partner, as such,” arguing it restricted the exclusion to partners functioning in a limited capacity. The Fifth Circuit rejected this as grammatically incorrect. Instead, it held that “as such” is recursive (meaning “as a limited partner”) and serves to clarify the treatment of dual-status partners. It ensures that if a partner is both a general partner and a limited partner in the same entity, the exception applies only to the share they hold as a limited partner.

III. Strategic Value for Taxpayers Outside the Fifth Circuit  

While Sirius only is binding precedent in the Fifth Circuit (Louisiana, Mississippi, and Texas), its value as persuasive authority is substantial for the following reasons.  

• • A “Circuit Split” and Supreme Court Potential: There is now a direct conflict between the Fifth Circuit and the Tax Court’s nationwide position. This split is likely to be deepened or resolved as Denham and Soroban move through the First and Second Circuits, respectively.  
  • The Loper Bright/Bittner “Fair Notice” Argument: The Fifth Circuit relied on the fact that for over 40 years, the IRS’s own instructions for Form 1065 defined a limited partner based on limited liability. Under recent Supreme Court guidance (Loper Bright and Bittner), the Court found it “difficult for taxpayers to even know about, let alone comply with” a secret, unwritten functional test that contradicts decades of agency guidance. This administrative law argument is potent in any jurisdiction.  
  • A Blueprint for Litigation: Taxpayers currently under audit or in the Tax Court now have a high-court roadmap for challenging the “functional analysis” test. It shifts the argument from a factual defense (trying to prove passivity) to a legal defense (arguing the test itself is unauthorized). 

 

IV. Conclusion

Sirius provides a necessary check on the “active partner” disqualification trend. However, it is important to note that the Fifth Circuit expressly limited its holding to state-law limited partnerships. It declined to address whether members of LLCs or LLPs qualify for the exception, although it suggested that if an LLC member's rights and obligations are identical to a limited partner's, a similar result might follow.        

If you have additional questions or would like to discuss this issue in more detail following the reading of this FGMK Internal Guidance, please contact FGMK Tax Partner David Benz.    

 

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