August 18, 2026

A recent withdrawal and replacement of a Fifth Circuit ruling may impact certain investment fund managers’ ability to claim exemption from self-employment tax under Internal Revenue Code (“Code”) Section 1402(a)(13) on their distributive shares of management fee income.

As discussed in our previous January 2026 client alert, the Fifth Circuit delivered a significant win for investment fund managers organized as limited partners. The court overruled a Tax Court opinion and held that if a partner is classified as a limited partner under state law, their share of partnership income is exempt from self-employment tax. The IRS argued that the exemption should only apply to passive partners, but the Fifth Circuit disagreed. This was cautiously viewed as significant support for the position that a limited partner’s share of management fee income would be exempt from self-employment tax.

However, on August 13, 2026, the Fifth Circuit panel withdrew its January opinion and replaced it with a new one. The revised ruling adopts a narrower definition of limited partner that depends on the partner’s role in running the business. Under this new standard, partners who are actively managing the partnership’s business may not qualify as limited partners for self-employment tax purposes, even if state law identifies them as such. The case has been remanded for further proceedings under this new standard, and similar cases are pending in the Second and Third Circuits.

With those appeals pending, it is possible there may not be a unified rule until this matter is before the U.S. Supreme Court. It is unknown how those cases will resolve and whether they will hinder limited partners’ ability to claim an exemption from self-employment taxes under Code Section 1402(a)(13).

What This Means for Limited Partners

The self-employment tax exemption is now at risk for limited partners receiving distributive shares of income through an investment manager organized as a limited partnership. The exemption will turn on whether a limited partner is actively engaged in the business of the investment manager, but the standard for active participation is not yet clearly defined.

For other equity holders in investment managers not organized as limited partnerships (e.g., LLCs), the tax posture is likely unchanged, and their distributive share will remain subject to self-employment tax.

This is an extremely fact-specific inquiry, and we recommend fund managers be aware of developments in the law.

For additional information, please reach out to CFM Tax Practice Chair Kevin Leiske or associate Miles B. Anderson.