The First Circuit Court of Appeals heard oral arguments on February 5, 2026, in Denham Capital Management LP v. Commissioner. While the tax community has been focused on the substantive split regarding the "limited partner" exception to self-employment tax—highlighted by the Fifth Circuit’s recent taxpayer-favorable ruling in Sirius Solutions LLLP—the First Circuit panel devoted the majority of the hour-long session to a threshold procedural question: Does the Tax Court effectively have jurisdiction under TEFRA to determine Net Earnings from Self-Employment (NESE)?

The panel, consisting of Chief Judge Barron and Judges Lipez and Rikelman, vigorously questioned counsel on the statutory interpretation of "partnership items" versus "affected items," suggesting a possibility that the court could dispose of the case on jurisdictional grounds without reaching the merits of Section 1402(a)(13).

1. The Jurisdictional Threshold: Is NESE a "Partnership Item"?

The Appellant (Denham) challenged the Tax Court’s jurisdiction, arguing that NESE is not a "partnership item" under the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) and therefore cannot be adjusted in a partnership-level proceeding (FPAA).

Appellant’s Position: Counsel for Denham argued that for an item to be a "partnership item," Section 6231(a)(3) (prior to repeal) requires that a provision of Subtitle A must require the partnership to "take [the item] into account for the partnership’s taxable year".

"Taken into Account" vs. Reporting: Counsel argued that merely reporting an item on Form 1065 (a requirement derived from Subtitle F) does not constitute "taking it into account" under Subtitle A,.
Individual Calculation: Denham contended NESE is a derivative calculation made at the partner level, not the partnership level. At most, NESE is an "affected item," which requires partner-level determinations.

Judicial Inquiry:

The "Derivative" Nature of NESE: Judge Lipez pushed back against the Appellant, suggesting NESE is "inescapably linked to the totality of the partnership income." He posited that because NESE cannot be calculated until the partnership determines its income, deductions, and credits, it is conceptually a partnership item.
Statutory Text: Chief Judge Barron scrutinized the Appellant’s textual argument. He questioned whether the phrase "under any provision of subtitle A" in the statute modifies "partnership item" or merely modifies "taxable year," referencing the Federal Circuit’s decision in Keener,.
Reporting Authority: Judge Barron also pressed the Appellant on the practical implications: if a requirement to report information (like NESE) exists on the tax form, does that not inherently mean the partnership must take it into account?

Commissioner’s Response: The government argued that partnerships do not pay tax, so "taking into account" simply means reporting items that flow through to partners.

Counsel contended that Subtitle A (specifically Sections 702 and 704) requires partnerships to determine the character of income, which flows into the 1402 analysis.
The government relied on United States v. Woods to argue that TEFRA was designed to aggregate determinations that affect all partners, avoiding duplicative proceedings.

The "Bypass" Rule: Judge Barron and Appellant’s counsel discussed the "bypass rule" (hypothetical jurisdiction). They agreed that the court generally can only bypass a jurisdictional hurdle if it rules on the merits in favor of the party challenging jurisdiction. Thus, if the First Circuit intends to affirm the Tax Court (ruling against Denham), it must affirmatively decide the jurisdictional question.

2. The Substantive Issue: Defining "Limited Partner, As Such"

On the merits, the dispute centers on whether Denham’s partners—who were active in management but held limited liability under Delaware law—qualify for the exclusion from NESE under Section 1402(a)(13). The Tax Court applied a "functional analysis" (passive investor test), citing Soroban and Renkemeyer,.

Appellant’s Position: Denham argued that in 1977 (when the statute was enacted), "limited partner" was defined by state-law limited liability, not by passivity. Counsel contended the "as such" language was intended only to address "dual status" partners (those holding both general and limited interests) to ensure the exception applied only to their limited interest.

Judicial Inquiry:

"As Such" = Role vs. Status: Judge Lipez expressed skepticism regarding Denham’s interpretation of "as such." He noted that "limited liability" is a legal consequence, whereas "as such" suggests a capacity or role analysis. He observed that the government’s "passive investor" test seems "much more consistent with the ‘as such’ language" than a test based solely on liability status.
Dictionary Definitions: Judge Rikelman challenged the Appellant’s reliance on 1968 dictionary definitions. She pointed out that Black’s Law Dictionary from that era defined a limited partner not just by limited risk, but as one whose "responsibility is restricted," supporting a functional analysis.
Congressional Intent: Judge Barron questioned the logic of the Appellant’s position, asking why Congress would intend to exempt full-time employees from social security taxes solely because they benefit from limited liability under state law. Conversely, he asked the government why Congress used the specific term "limited partner" if it actually meant "passive investor," particularly if the law was in flux at the time.

Commissioner’s Response: The government argued that the "limited partner" label is not controlling. Counsel asserted that under 1977 case law (e.g., Delaney), a functional analysis was already applicable: if limited partners exercised control, they lost their limited partner protections. Therefore, the "passive investor" standard applied by the Tax Court is consistent with the statutory intent to prevent income from active trade or business from escaping the SECA wage base.

Conclusion

While the Fifth Circuit in Sirius Solutions recently rejected the Tax Court’s functional analysis, the First Circuit panel appeared more sympathetic to the government’s "role-based" interpretation of Section 1402(a)(13). However, the intense scrutiny regarding TEFRA jurisdiction suggests the court may issue a ruling on procedural grounds. If the court finds NESE is not a partnership item, it would vacate the Tax Court’s decision for lack of jurisdiction, leaving the substantive definition of "limited partner" for another day—or for individual partner-level deficiency proceedings.

Prepared with assistance from NotebookLM.