Key Points

  • The Second Circuit held that 'limited partner' under Section 1402(a)(13) means a partner who has limited liability and does not run, manage, or control the partnership's business.
  • Net earnings from self-employment is a partnership item under TEFRA, so disputes about limited-partner status are resolved in a single partnership-level proceeding rather than partner-by-partner.
  • The court looked to the term's ordinary meaning in 1977, when Congress enacted Section 1402(a)(13), and found that limited partners were understood to lack management authority.
  • The three Soroban principals worked full time, sat on all governing committees, and exercised managerial control, making them 'limited partners in name only.'
  • The ruling aligns with a recent Fifth Circuit decision in K Alain and applies to partnerships in New York, Connecticut, and Vermont.

The Second Circuit ruled Thursday that three hedge fund principals must pay self-employment tax on $141.5 million in distributive shares, holding that partners who run their firm's business do not qualify as 'limited partners' under the Internal Revenue Code regardless of how their partnership agreement labels them.

In Soroban Capital Partners LP v. Commissioner of Internal Revenue, a unanimous panel affirmed the Tax Court and held that the term 'limited partner' in Section 1402(a)(13) of the Code means 'a partner who, in addition to having limited liability, does not run, manage, or control the partnership's business.'

Judge Chin, writing for a panel that included Judges Calabresi and Merriam, rejected Soroban's argument that 'limited partner' simply means any partner with limited liability under state law. The court looked to the term's ordinary meaning in 1977, when Congress enacted Section 1402(a)(13), and found that lack of managerial control was a defining feature of limited-partner status.

The ruling aligns the Second Circuit with a recent Fifth Circuit decision in K Alain L.L.L.P. v. Commissioner. A similar case, Denham Capital Management LP v. Commissioner, is pending before the First Circuit.

Soroban Capital Partners is a Delaware limited partnership that serves as the investment manager for hedge funds. In 2016 and 2017, the firm earned approximately $247 million from management and incentive fees. Its three principals—Eric W. Mandelblatt, Gaurav Kapadia, and Scott Friedman—worked full time running the business, logging between 2,300 and 2,500 hours per year each.

Mandelblatt served as Managing Partner and Chief Investment Officer; Kapadia was Co-Managing Partner; and Friedman was Head of Trading and Risk Management. All three sat on each of Soroban's four governing committees.

Despite this operational involvement, Soroban allocated roughly 99% of its ordinary income to the principals as limited partners. The principals' distributive shares totaled approximately $141.5 million over two years—more than 55 times the $2.5 million they received in guaranteed payments for services.

On its partnership returns, Soroban claimed the principals' distributions were exempt under Section 1402(a)(13), which provides that the distributive share of a 'limited partner, as such' is not subject to self-employment tax. The IRS disagreed and issued notices recharacterizing the principals' shares as net earnings from self-employment.

Soroban challenged the adjustments in Tax Court, arguing its principals were limited partners because they held limited liability under Delaware law. The firm also contended the IRS used the wrong procedures.

Tax Court Judge Buch rejected both arguments. He held that the limited-partner exception 'does not apply to a partner who is limited in name only' and that '[b]ut for the three Principals, Soroban would not exist.'

On appeal, the Second Circuit first addressed jurisdiction. The court held that net earnings from self-employment is a 'partnership item' under TEFRA, so disputes about limited-partner status are resolved in a single partnership-level proceeding rather than partner-by-partner litigation.

On the merits, Judge Chin quoted the Supreme Court's 1956 decision in Commissioner v. Southwest Exploration Co. for the principle that 'tax law deals in economic realities, not legal abstractions.' The court examined contemporaneous dictionaries, treatises, and state statutes and found that limited partners were understood in 1977 to lack management authority.

The phrase 'as such' in Section 1402(a)(13), which excludes the distributive share 'of a limited partner, as such,' reinforced the interpretation. The phrase means 'in that capacity,' the court explained, limiting the exemption to income earned in a partner's capacity as a passive investor.

Congress enacted the provision in 1977 to address an abuse: passive investors accumulating Social Security credits by placing small amounts in limited partnerships. The House Report described the excluded income as 'basically of an investment nature.'

The court rejected Soroban's reliance on a 1997 congressional moratorium that blocked final IRS regulations defining 'limited partner.' Judge Chin found this post-enactment history of limited relevance, noting that the proposed regulation's bright-line rules 'differ significantly from the functional approach we discern today.'

The Managed Funds Association and The Real Estate Roundtable filed amicus briefs supporting Soroban. The Tax Law Center at NYU Law filed in support of the Commissioner.

The ruling means hedge fund and private equity principals who actively manage their firms cannot shelter distributive income from the 15.3% self-employment tax by labeling themselves limited partners. Partners whose contributions are genuinely passive remain eligible for the exemption.

Shay Dvoretzky of Skadden, Arps, Slate, Meagher & Flom argued for Soroban, with Parker Rider-Longmaid on the brief. Norah E. Bringer of the Justice Department's Tax Litigation Branch argued for the Commissioner, with Ellen Page DelSole on the brief.

Soroban may seek further review. The decision is Soroban Capital Partners LP v. Commissioner of Internal Revenue, Nos. 25-2079 (L), 25-2250 (CON), decided September 17, 2026.