Do LLC and LP Owners Owe Self-Employment Tax? Where the Limited Partner Exception Stands

Partners in a business generally owe self-employment tax on their share of its income, but the tax code exempts a "limited partner's" share, and in 2026 the federal appeals courts narrowed who counts. On September 17, 2026, the Second Circuit held in Soroban Capital Partners that a limited partner is one who has limited liability and does not run, manage, or exert control over the partnership. The Fifth Circuit, in an August 2026 substitute opinion, adopted a similar test: a partner who plays no significant role in managing or running the business. Both decisions reject the idea that the state-law label "limited partner" is enough on its own. For LLC members the answer is murkier still, because the statute does not mention LLCs and Treasury has never finalized rules for them. The practical upshot for owners who actively run a business through an LP or LLC: assume self-employment tax applies unless your role is truly passive, and remember that escaping self-employment tax can trigger the 3.8% net investment income tax instead.

What is the limited partner exception?

Self-employment tax is the Social Security and Medicare tax on business income for people who are not employees. For 2026 it is 12.4% for Social Security on net earnings up to $184,500 plus 2.9% for Medicare with no cap, and a further 0.9% Additional Medicare Tax applies above $200,000 of earnings for single filers and $250,000 for joint filers. Net earnings are 92.35% of business income, and half of the tax (excluding the additional 0.9%) is deductible.

General partners owe it on their distributive share of partnership business income. Section 1402(a)(13) carves out "the distributive share of any item of income or loss of a limited partner, as such," while keeping guaranteed payments for services fully subject to the tax. Congress added the exception in 1977, when limited partners were typically passive investors. The statute never defined "limited partner," and that gap is what the courts have spent three years filling.

What did the courts decide in 2026?

The litigation began with the Tax Court's 2023 decision in Soroban, which held that a state-law limited partner is not automatically exempt and that a functional analysis applies: a partner who acts like an active owner does not qualify. Two investment managers and a consulting firm appealed to three different circuits.

The Fifth Circuit's January 2026 opinion briefly held that limited liability alone was enough, which would have been a broad win for taxpayers. It withdrew that opinion in August and replaced it with the "significant role" test. The Second Circuit noted there "appears to be little daylight" between its standard and the Fifth Circuit's, and both courts said a limited partner may provide some services so long as those services do not amount to managing or running the business. In Soroban itself, the principals worked full time, managed the investments, and sat on governing committees, so their shares, roughly $141.5 million over two years, were held subject to self-employment tax.

Neither decision is the last word nationally. Further appeals remain possible, the First Circuit has not ruled, and none of the opinions decides how LLC members are treated. But the direction is clear: the exception now turns on what a partner actually does.

What about LLC members?

The statute speaks of limited partners, and an LLC member is not one under state law. In 1997 Treasury proposed regulations that would have denied the exception to any member who had personal liability for the entity's debts, had authority to contract on its behalf, or worked more than 500 hours a year in the business. Congress then imposed a temporary moratorium on final rules, which expired in 1998, and the proposed regulations were never finalized. Many practitioners still use the 1997 tests as an informal guide, but they are not binding.

The Tax Court has applied a functional approach to professionals operating through LLPs and PLLCs, holding in Renkemeyer (2011) and Castigliola (2017) that members whose income came from their own services were not limited partners. Treasury's 2026-2027 priority guidance plan, released in September 2026, contains no project on the issue. An LLC member who actively manages the business should assume the exception does not apply.

How does the net investment income tax fit in?

This is where the "passive income" question becomes important, because three different tax regimes ask whether income is active or passive, and they do not ask in the same way.

Self-employment tax turns on whether you are a limited partner under the tests above.

The 3.8% net investment income tax applies to investment income and to business income that is passive to you under Section 469, above $200,000 of modified AGI for single filers and $250,000 for joint filers. It excludes business income in which you materially participate and any income already subject to self-employment tax.

The Section 469 passive activity rules decide whether losses can offset other income, and they have their own material participation tests. A limited partner can materially participate only by working more than 500 hours, by having materially participated in five of the prior ten years, or, for a personal service business, in any three prior years.

The interplay produces three outcomes. A partner subject to self-employment tax pays that tax and not the NIIT on the same income. A limited partner who escapes self-employment tax but does not materially participate generally owes the NIIT instead. And a limited partner who escapes self-employment tax while materially participating can, in principle, owe neither, a gap the Congressional Budget Office has described and several Social Security reform bills have proposed to close. The new court standards shrink that gap, because a partner active enough to materially participate will often also fail the "manage or run" test, but the two tests are not identical.

A worked example: one partner, three outcomes

The following is a hypothetical illustration using 2026 figures for a married partner filing jointly with no wages from other sources, whose other income already exceeds the NIIT threshold. The partner's distributive share of partnership business income is $1,000,000.

If the share is subject to self-employment tax, net earnings are $923,500. Social Security tax on the first $184,500 is $22,878, Medicare tax at 2.9% is $26,782, and the Additional Medicare Tax on earnings above $250,000 is $6,062, for about $55,721 in total, of which roughly $24,830 is deductible.

If the share qualifies for the limited partner exception and the partner does not materially participate, the self-employment tax disappears but the 3.8% NIIT applies, about $38,000.

If the share qualifies for the exception and the partner does materially participate, neither tax applies. Under the 2026 court decisions, a partner in that position should expect scrutiny, because the activity that creates material participation is close to the activity that defeats the exception. The figures are hypothetical and ignore income tax, apart from the deduction for half of self-employment tax in the first case, which reduces income tax by roughly $9,200 at a 37% rate.

What should owners do now?

Review your actual role, not the label.Partners who hold limited partner interests but manage the business, run investments, sit on management committees, or hire and fire should assume self-employment tax applies: the Soroban and K Alain decisions bind the Second and Fifth Circuits, and elsewhere, including Wisconsin, the Tax Court continues to apply its own functional test.

Revisit how you are paid.Guaranteed payments for services are always subject to self-employment tax. Some firms have restructured, for example by having active principals hold their interests through S corporations, where reasonable wages are subject to payroll tax but remaining income is not. That approach has its own requirements and trade-offs, discussed in the business entity primer.

Look at open years.Partners who claimed the exception on prior returns while playing a significant management role should discuss exposure with their CPA, including whether amended returns or protective positions make sense while Denham is pending.

Do not overlook family partnerships.Passive family members in a family limited partnership generally remain well within the exception; the cases concern partners who run the business.

Key numbers at a glance

Frequently asked questions

Do limited partners pay self-employment tax?Not on their distributive share if they qualify for the limited partner exception, but after the 2026 decisions in Soroban (Second Circuit) and K Alain (Fifth Circuit), qualifying requires more than the label. A limited partner who runs, manages, or plays a significant role in the business is generally subject to the tax.

Do LLC members pay self-employment tax?Usually, if they are active in the business. The statute does not address LLC members, Treasury's 1997 proposed rules were never finalized, and the Tax Court has applied a functional approach to members whose income comes from their own services.

What did the Second Circuit decide in Soroban?On September 17, 2026, it affirmed the Tax Court and held that a limited partner is one with limited liability who does not run, manage, or otherwise exert control or managerial authority over the partnership.

If I avoid self-employment tax, do I owe the net investment income tax instead?Often yes. Income excluded from self-employment tax is generally subject to the 3.8% NIIT if you do not materially participate in the business. A partner who materially participates may owe neither, although the new court standards make that combination harder to sustain.

Are guaranteed payments subject to self-employment tax?Yes. Guaranteed payments for services are subject to self-employment tax regardless of whether the recipient is a limited partner.

Is the law settled?Not entirely. The First Circuit has not ruled in Denham, further appeals remain possible, and no court has resolved how LLC members are treated. The direction, however, is consistently toward judging partners by what they actually do.

Sources

• Soroban Capital Partners LP v. Commissioner, No. 25-2079 (2d Cir. Sept. 17, 2026), U.S. Court of Appeals for the Second Circuit
• K Alain, L.L.L.P. v. Commissioner, No. 24-60240 (5th Cir. Aug. 12, 2026), U.S. Court of Appeals for the Fifth Circuit
• Recent circuit court decisions coalesce on scope of LP self-employment tax exception, Cooley, October 13, 2026
• Self-employment tax (Social Security and Medicare taxes), Internal Revenue Service
• Questions and answers on the net investment income tax, Internal Revenue Service
• 26 CFR 1.469-5T: Material participation, Legal Information Institute, Cornell Law School
• Contribution and benefit base, Social Security Administration
• Budget options: tax all pass-through business income under the net investment income tax or self-employment tax, Congressional Budget Office, December 2024