Second Circuit Affirms Tax Court in Soroban, Adopts Management-and-Control Standard for Self-Employment Tax Exception Under Code Section 1402(a)(13)

On September 17, 2026, the U.S. Court of Appeals for the Second Circuit affirmed the Tax Court in Soroban Capital Partners LP v. Commissioner.¹ The court held that a “limited partner” under Code Section 1402(a)(13) “means a partner who, in addition to having limited liability, does not run, manage, or control the partnership’s business.” Because the three principals of Soroban Capital Partners LP (Soroban) worked full time in the business and exercised managerial control, the court held that their distributive shares for 2016 and 2017 were included in net earnings from self-employment and therefore were subject to self-employment tax.

The decision rejects the position that state-law limited partner status and limited liability, standing alone, are sufficient. At the same time, the court did not hold that providing any services is disqualifying. It stated that a partner may provide some services or otherwise play a role in the partnership and still qualify, provided those activities do not amount to controlling, managing, or running the business. The holding generally aligns the Second Circuit’s approach with the Fifth Circuit’s; a similar appeal remains pending in the First Circuit.

Background

Code Section 1402(a) generally includes in net earnings from self-employment (NESE) a partner’s distributive share of income or loss from a trade or business carried on by a partnership. Code Section 1402(a)(13), however, excludes “the distributive share of any item of income or loss of a limited partner, as such,” other than certain guaranteed payments for services under Code Section 707(c). The Code does not define “limited partner” for this purpose.

The facts, as stated by the court, were as follows. Soroban, a Delaware limited partnership, served as investment manager to a group of hedge funds. Its three principals held limited partner interests in Soroban and were also members of Soroban’s general partner. From Soroban’s founding through the end of 2017, one principal had contributed several million dollars of capital, while the other two had contributed none. During the years at issue, the principals worked full time; managed Soroban’s portfolio investments; served on nearly all of its governing committees; and participated in hiring, firing, promotion, termination, and evaluation decisions. Soroban paid the principals material guaranteed payments and allocated roughly 99% of its remaining ordinary income to them as limited partners. Soroban reported the guaranteed payments, but not the distributive shares, as NESE.

The Tax Court applied a functional analysis and concluded that the principals were “limited partners in name only.” It sustained the IRS’s adjustments in full. Soroban appealed, arguing principally that formal limited partner status and limited liability, standing alone, were sufficient to qualify for the exclusion under Code Section 1402(a)(13).

The Second Circuit’s Holding and Rationale

The Second Circuit rejected Soroban’s status-based interpretation. Looking to the ordinary meaning of “limited partner” in 1977, when Code Section 1402(a)(13) was enacted, the court concluded that the term then had two defining features: limited liability and a lack of managerial control. Contemporary dictionaries, treatises, and state limited partnership statutes, in the court’s view, treated a partner who controlled the business as outside the traditional limited partner role.

The court also relied on the phrase “as such,” which it read to mean “in that capacity.” In the court’s view, the exception therefore applies to income earned in a limited partner capacity — income attributable to an investment in the partnership — rather than income earned through management of the business. The guaranteed-payment carveout did not alter that conclusion. Although the carveout confirms that a limited partner may perform some services, the court reasoned that performing services does not necessarily amount to running, managing, or controlling the partnership.²

Finally, the court concluded that the surrounding statutory structure and legislative history of Code Section 1402(a) supported distinguishing passive investment income from income earned through active operation of a business. It also rejected Soroban’s reliance on IRS Form 1065 instructions and the 1997 congressional moratorium on regulations defining “limited partner,” concluding that neither displaced the term’s 1977 ordinary meaning.

Application to Soroban

On the facts before the court, applying that standard, the court concluded that the principals did not qualify as limited partners. Although Soroban’s partnership agreement formally vested management authority in its general partner, the principals were themselves members of the general partner and, as a practical matter, managed and ran Soroban. The court emphasized their full-time roles, investment management responsibilities, committee service, and personnel authority.

The court accordingly affirmed the inclusion of all the principals’ distributive shares in NESE.

The court did not apportion those shares between a return on the partners’ capital interests on the one hand and income attributable to services or management on the other, despite the record reflecting that the partners in question were co-founders of the business and that one principal had contributed millions of dollars of capital. Yet the court’s own rationale might have been read to invite that inquiry. In construing the words “as such” in the statute, the court limited the exception to “income a partner earns in their capacity as a limited partner — that is, income attributable to the partner’s investment in the partnership, not to their management of the business.” That reasoning distinguishes between a return on invested capital and compensation for services or management, and it could support excluding the portion of a distributive share attributable to a partner’s capital interest in a partnership even where the partner also manages the partnership and its business in a separate general partner capacity. Nevertheless, having concluded that the principals exercised control and managerial authority over Soroban, the court treated their entire distributive shares as NESE without further explanation as to why this outcome was consistent with the “economic realities” of the arrangement.³

Relationship to the Fifth Circuit’s Recent K Alain Decision

One month earlier, in K Alain, L.L.L.P. v. Commissioner (formerly Sirius Solutions, L.L.L.P. v. Commissioner), the Fifth Circuit held that a limited partner is one “who plays no significant role in managing or running a business.” See our August 2026 Sidley Update. Although K Alain expressly rejected the Tax Court’s “passive investor” formulation, the Second Circuit observed that there appeared to be “little daylight” between the standards and that Soroban’s principals would fail under either one.

Both the Second and Fifth Circuits therefore recognize that a limited partner may perform some services without losing eligibility for the exception but treat meaningful management or control as disqualifying. Neither opinion defines the boundary between permissible participation and a disqualifying management role.

TEFRA Jurisdiction

On the separate jurisdictional issue, the Second Circuit held that NESE constituted a partnership item subject to partnership-level proceedings under the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) and that the Tax Court therefore had jurisdiction to decide the adjustments.

Practical Implications and Unresolved Questions

The opinion is particularly significant for structures in which the same individuals hold limited partner interests and exercise authority through a separate general partner or management entity. Formally allocating authority to the general partner is insufficient if the limited partners themselves actually run, manage, or control the business.

The decision leaves several questions open, including these:

• The level of service or participation that remains permissible before a partner is considered to run, manage, or control the business. Neither Soroban nor K Alain provides a bright-line rule.
• Whether, and to what extent, a managing partner with a capital interest in a partnership may exclude from NESE the portion of a distributive share attributable to a return on that partner’s capital investment.
• How Code Section 1402(a)(13) applies to members of limited liability companies, partners in limited liability partnerships, and holders of interests in other entities classified as partnerships for federal tax purposes but not organized as state-law limited partnerships.
• How the First Circuit will resolve the similar appeal in Denham Capital Management LP v. Commissioner. That decision may further clarify whether the appellate courts are converging on a common management-and-control standard or diverging at the margins. A divergence among the circuits could also increase the likelihood of Supreme Court review.

Taxpayers with partnership structures that may be affected by the decision should review those structures and consult with the Sidley lawyer with whom they usually work or one of the contacts listed below.

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¹Soroban Capital Partners LP v. Commissioner, Nos. 25-2079 (L), 25-2250 (CON), slip op. (2d Cir. Sept. 17, 2026).
²The opinion’s reasoning is not entirely uniform. The court states the management and control standard in several ways — that a limited partner cannot “run, manage, or control the partnership’s business”; that a limited partner cannot “otherwise exert control or managerial authority over the partnership”; and that a limited partner cannot “take part in running the business.” Elsewhere, it justifies its interpretation of the statute on the basis that Code Section 1402(a)(13) was intended to reach only income from passive investment in a partnership. Yet, in addressing the statute’s reference to guaranteed payments, the court states that it does “not disagree that a limited partner in 1977 could provide some services to the partnership,” reasoning that “merely providing services does not necessarily equate to running the business.” But in addressing Soroban’s reliance on IRS administrative materials, the opinion states that for purposes of Code Section 1402(a)(13), “a limited partner may not participate in the partnership’s business.” These varying formulations are difficult to reconcile.3
³This approach creates a standard that differs from the one applied in the S corporation context, where a shareholder’s pass-through income and distributions with respect to stock are not subject to employment or self-employment tax regardless of how actively the shareholder participates in the business, subject to the Internal Revenue Service’s ability to recharacterize purported pass-through income and distributions as wages where the S corporation fails to pay the shareholder reasonable compensation for services.