Soroban Decision Narrows Limited Partner Self-Employment Tax Exception

The U.S. Court of Appeals for the Second Circuit has limited the availability of a self-employment tax exclusion for certain distributive shares to limited partners. In Soroban Capital Partners LP v. Commissioner, Nos. 25-2079 (L), 25-2250 (CON), slip op. (2d Cir. September 17, 2026), the court held that a partner must function as a limited partner, not merely be designated one under state law, to qualify for the exception in Internal Revenue Code (IRC) Section 1402(a)(13). The decision has immediate relevance for investment managers, private equity firms, hedge funds, professional services firms, and other partnerships where owners receive substantial distributive shares while also participating in management activities.  

IRC Section 1402(a) generally includes a partner’s distributive share of partnership business income in “net earnings from self-employment.” However, IRC Section 1402(a)(13) provides an exclusion for a limited partner’s distributive share, except for certain guaranteed payments for services.  

The dispute in Soroban centered on who qualifies as a “limited partner.” 

Soroban is a Delaware limited partnership that served as investment manager to a group of hedge funds. Its three founding members were principals with limited partnership interests and were also members of the partnership’s general partner. During 2016 and 2017, they worked 2,300 to 2,500 hours per year, managed portfolio investments and exposures, served on all of Soroban’s governing committees, and participated in personnel decisions. Soroban’s senior management team reported directly to two of the principals.  

The firm allocated approximately 99% of its ordinary income to the principals. Their distributive shares totaled roughly $141.5 million for the two years, compared with roughly $2.5 million in guaranteed payments for services. Soroban excluded the distributive shares from self-employment income. The Internal Revenue Service (IRS) disagreed with the principals’ categorization as limited partners and adjusted the partnership’s net earnings from self-employment accordingly.  

The Tax Court agreed with the IRS, and the Second Circuit affirmed the Tax Court, holding that the principals were not limited partners for purposes of IRC Section 1402(a)(13).   

The court focused on the meaning of “limited partner” when Congress enacted the provision in 1977. It concluded that the term carried two core characteristics at that time: limited liability and an absence of managerial control. The court also relied on the statutory phrase “as such,” reasoning that the exclusion was limited to income a partner earns in their capacity as a limited partner and not their management of the business.  

The practical issue is larger than the terminology used in a partnership agreement.   

The Soroban decision indicates that state law partnership designations do not resolve the federal self-employment tax question. A partner who holds a limited partnership interest can still fall outside IRC Section 1402(a)(13) if the partner exercises meaningful control over the partnership’s business. 

The court expressly recognized that a limited partner could perform some services without necessarily losing the exclusion. The line drawn by the court is managerial control and participation in running the business.  

That distinction will require careful attention to the facts of each case, including governance rights, committee responsibilities, decision-making authority, operational involvement, and the relationship between a partner’s services and the partnership’s income-generating activities. 

Ryan’s Perspective 

Soroban makes the substance of a partner’s role central to the IRC Section 1402(a)(13) analysis. Not every service performed by a limited partner causes self-employment tax. Instead, the court drew a line between limited participation and actually running or controlling the partnership.  

For partnerships that have relied on limited partnership status based on state law to exclude distributive shares from self-employment income, the key question is now whether the partner’s responsibilities are consistent with functioning as a limited partner under this framework. That analysis should look beyond titles and ownership documents to the partnership’s governance structure and how the business operates in practice. 

 The decision also increases the importance of monitoring developments in other circuits. In the First Circuit case Denham Cap. Mgmt. LP v. Comm’r of Internal Revenue, No. 25-1349 (1st Cir. filed April 11, 2025), the government has already cited the new Soroban decision to argue for the same outcome. The Fifth Circuit also recently issued a substituted ruling in K Alain, L.L.L.P. v. Comm’r of Internal Revenue, No. 24-60240, 2026 WL 2333930 (5th Cir. August 12, 2026), largely agreeing with the Soroban analysis and defining a limited partner as one who “plays no significant role in managing or running a business.”  

For affected partnerships, now is a useful time to document the roles of active partners, review governance and management rights, and reassess the support for IRC Section 1402(a)(13) positions before the next examination.  

The material presented in this communication is intended to provide general information only and should solely be seen as broad guidance and not directed to the particular facts or circumstances of any individual who may read this publication. No liability is accepted for acts or omissions taken in reliance upon the content of this piece. Before taking (or not taking) any action, readers should seek professional advice specific to their situation from Ryan, LLC or other tax professionals.