Soroban Capital Partners LP v. Commissioner, 161 T.C. 310 (2023); Soroban Capital Partners LP v. Commissioner, T.C. Memo. 2025-52; Soroban Capital Partners LP v. Commissioner, No. 25-2079 (2d Cir. 2026) (Oral Argument Transcript).

For tax professionals advising private equity funds, hedge funds, and closely held businesses, the ongoing litigation in Soroban Capital Partners LP v. Commissioner represents one of the most critical developments in self-employment tax controversy in decades. At the heart of the dispute is whether active, service-providing individual partners in a state-law limited partnership can utilize the limited partner exception of Internal Revenue Code (I.R.C.) Section 1402(a)(13) to exclude their distributive shares of ordinary partnership income from self-employment taxes under the Self-Employment Contributions Act (SECA). With over $140 million in distributive shares at stake in this single case, the controversy has progressed from foundational battles over Tax Court jurisdiction to a high-stakes appeal before the U.S. Court of Appeals for the Second Circuit. This article provides a highly technical analysis of the two underlying Tax Court decisions, the key items before the Second Circuit appellate panel, the detailed debates and concerns raised by the judges during oral arguments, and the broader compliance and risk mitigation strategies for CPAs and EAs.

The Statutory and Regulatory Baseline

The statutory path to this controversy begins with Section 1401(a), which imposes a tax on the self-employment income of individuals. Under Section 1402(b), "self-employment income" consists of "the net earnings from self-employment derived by an individual... during any taxable year." Section 1402(a) defines "net earnings from self-employment" as the gross income derived by an individual from any trade or business carried on by such individual, plus his distributive share of income or loss described in Section 702(a)(8) from any trade or business carried on by a partnership of which he is a member.

However, Section 1402(a)(13) provides a critical carveout, commonly referred to as the limited partner exception:

"there shall be excluded the distributive share of any item of income or loss of a limited partner, as such, other than guaranteed payments described in section 707(c) to that partner for services actually rendered to or on behalf of the partnership to the extent that those payments are established to be in the nature of remuneration for those services."

This exception was originally enacted in 1977 as Section 1402(a)(12) under the Social Security Amendments of 1977, Pub. L. No. 95-216, § 313(b). The legislative history indicates that Congress intended to address a specific "mischief"—namely, the marketing of limited partnership investments as a mechanism for passive investors to manufacture self-employment income and thereby obtain Social Security benefits. As the Tax Court later noted, the exception "was enacted to exclude earnings that are of an investment nature" to prevent individuals who perform no services from obtaining Social Security coverage based solely on investment income.

In 1997, the Treasury Department and the IRS issued proposed regulations (Prop. Treas. Reg. § 1.1402(a)-2) attempting to establish a uniform definition of "limited partner" for SECA purposes. Under these proposed rules, an individual would not be treated as a limited partner if they had personal liability for partnership debts, possessed authority to contract on behalf of the partnership, or participated in the partnership’s trade or business for more than 500 hours during the taxable year. This proposal was met with fierce backlash from practitioners and Congress, culminating in Section 935 of the Taxpayer Relief Act of 1997, Pub. L. No. 105-34, which imposed a temporary moratorium prohibiting the Treasury from issuing any temporary or final regulations regarding the definition of a limited partner under Section 1402(a)(13) before July 1, 1998. The Senate expressed concern that the proposed rules "exceeded the regulatory authority of the Treasury Department and would effectively change the law administratively without congressional action."

Since the expiration of that moratorium in 1998, Congress has not enacted any statutory definition of "limited partner" for Section 1402(a)(13) purposes, and the Treasury has not finalized any regulations. Consequently, the IRS began challenging SECA exclusions for active partners through administrative audits, relying on the landmark Tax Court decision in Renkemeyer, Campbell & Weaver, LLP v. Commissioner, 136 T.C. 137 (2011). In Renkemeyer, which involved active partners in a law firm organized as a limited liability partnership (LLP), the Tax Court applied a functional analysis and held that the limited partner exception did not apply to partners who performed services in their capacity as partners. Until Soroban, however, the Tax Court had not squarely addressed whether a functional analysis test must also be applied to a partner in a state-law limited partnership, as opposed to an LLP or LLC.

The First Tax Court Decision: Establishing the Functional Analysis Test and TEFRA Jurisdiction

The procedural battle in Soroban Capital Partners LP v. Commissioner, 161 T.C. 310 (2023) arose from two cross-motions for summary judgment. The Tax Matters Partner (TMP) filed a Motion for Summary Judgment arguing that because Soroban is a state-law limited partnership and its limited partnership agreement formally designated the active partners as limited partners, Section 1402(a)(13) was satisfied as a matter of law. In the alternative, the taxpayer argued that the Tax Court lacked jurisdiction in partnership-level proceedings under the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) to inquire into the partners' individual roles. The Commissioner filed a Cross-Motion for Partial Summary Judgment, asserting that a functional analysis test must be applied to state-law limited partnerships and that such an inquiry is a partnership item properly within TEFRA jurisdiction.

Judge Buch, writing for the Tax Court, rejected the taxpayer's formalistic, label-based reading of the statute and ruled in favor of the Commissioner. The court's statutory interpretation relied heavily on the canon against surplusage, focusing on the specific words "as such" in Section 1402(a)(13). The court reasoned:

"If Congress had intended that limited partners be automatically excluded, it could have simply said 'limited partner.' By adding 'as such,' Congress made clear that the limited partner exception applies only to a limited partner who is functioning as a limited partner."

Analyzing the legislative history, Judge Buch observed that "Congress enacted section 1402(a)(13) to exclude earnings from a mere investment. It intended for the phrase 'limited partners, as such' used in section 1402(a)(13) to refer to passive investors." Thus, the court formally held:

"A functional analysis test should be applied when determining whether the limited partner exception under section 1402(a)(13) applies to limited partners in state law limited partnerships."

Addressing the jurisdictional question, the court examined whether this functional inquiry could be resolved at the partnership level under the TEFRA unified audit and litigation procedures. Under Section 6231(a)(3), a "partnership item" includes any item required to be taken into account under Subtitle A that is more appropriately determined at the partnership level, as well as the underlying legal and factual determinations. Treasury Regulation Section 301.6231(a)(3)-1(b) explicitly provides that partnership items include "the accounting practices and the legal and factual determinations that underlie the determination of the amount, timing, and characterization of items of income, credit, gain, loss, deduction, etc."

The Tax Court concluded that because a partnership is required to calculate and report net earnings from self-employment under Subtitle A, any factual inquiry into the roles of its partners is a necessary component of that calculation:

"A functional inquiry into the roles and activities of Soroban’s individual partners as required by section 1402(a)(13) involves factual determinations that are necessary to determine Soroban’s aggregate amount of net earnings from self-employment... Accordingly, the functional inquiry into their roles is a partnership item and appropriate for these proceedings."

The Second Tax Court Decision: Economic Reality Trumps Legal Labels on the Merits

Following the 2023 jurisdictional ruling, the parties submitted the case on the merits for decision without trial under Tax Court Rule 122. In Soroban Capital Partners LP v. Commissioner, T.C. Memo. 2025-52, the Tax Court was presented with the detailed facts surrounding Soroban's operational and financial structure for the 2016 and 2017 tax years.

Soroban is an investment firm organized as a Delaware limited partnership, with its principal place of business in New York. For federal tax purposes, its disregarded single-member LLC interests collapsed, leaving only three individual limited partners (the active Principals: Eric Mandelblatt, Gaurav Kapadia, and Scott Friedman) and one general partner (Soroban Capital Partners GP LLC, which was in turn owned and managed by the same Principals).

During the years in issue, Soroban generated substantial income from quarterly investment management fees (ranging from 0% to 1.5% of asset values) and annual performance-based compensation (ranging from 17% to 35% of capital appreciation) charged to 11 managed funds. Across 2016 and 2017, the funds paid Soroban a total of approximately $247 million, which the funds characterized as business expenses for management services.

On its Forms 1065, Soroban reported net earnings from self-employment of $2,035,395 in 2016 and $1,901,131 in 2017, representing only the guaranteed payments distributed to the Principals for services and the general partner's share of ordinary income. Soroban excluded the Principals' distributive shares of ordinary business income, which amounted to $77,663,962 in 2016 and $63,866,302 in 2017. The IRS adjusted these returns, proposing to increase net earnings from self-employment by these exact amounts—over $140 million in total.

Applying the functional analysis test established in its prior opinion and refined in Denham Capital Management LP v. Commissioner, T.C. Memo. 2024-114, the Tax Court evaluated several key factors:

Role in Generating Income: The court found that "the limited partners played an essential role in generating this income" and their unique skills and experience were indispensable. Mr. Mandelblatt served as Managing Partner and Chief Investment Officer with "final discretion on all portfolio-related matters," Mr. Kapadia was the Co-Managing Partner, and Mr. Friedman was the Head of Trading and Risk Management.
Operational Management and Committees: The Principals collectively managed the operations and risks of both the partnership and the managed funds, and all three served on all of the operational committees (Brokerage, Trade Allocation, Valuation, and Management Committees) that drove firm policy. They exercised ultimate control over hiring, firing, and employee evaluations.
Time Commitment: The Principals treated Soroban as their full-time employment. The partnership estimated that each Principal worked between 2,300 and 2,500 hours annually, and investor marketing materials explicitly stated that "100% of [the Principals’] time [was] devoted to the management and investment activities of [Soroban] and the funds it manages."
Client Marketing and Key-Man Provisions: Soroban heavily marketed the unique talents of the Principals to prospective investors. The governing fund agreements provided that if Mr. Mandelblatt were permanently incapacitated, a "Key-Man Event" would be triggered, granting investors the right to withdraw their funds on short notice. If all three Principals became unavailable, the funds would immediately liquidate. The court remarked, "But for the three Principals, Soroban would not exist."
Capital Contributions and Distributive Shares: Only Mr. Mandelblatt had contributed cash capital to the firm ($4.35 million between 2010 and 2013). Messrs. Kapadia and Friedman made zero cash capital contributions.

To defend its position, the taxpayer moved to reopen the record to introduce Soroban's Forms 1065 for the years 2010 through 2023, attempting to show that the partners' capital accounts fluctuated and that they made substantial capital contributions in post-audit years (2019, 2020, and 2021) to fund losses, thereby proving that their distributive shares represented a return on investment.

Judge Buch granted the motion to reopen the record solely to supplement the 2010 through 2015 tax returns, but analyzed the resulting data to devastating effect. He calculated the Principals' cumulative ordinary income as a percentage of their capital accounts, which revealed returns ranging from 45% to over 290,000% annually. This led the court to conclude:

"The Principals' shares of ordinary income bear no relationship to their capital contributed or their capital accounts... Thus it is clear that the partners’ distributive shares of the... firm’s income did not arise as a return on the partners’ investment and were not 'earnings which are basically of an investment nature.'"

Ultimately, Judge Buch held that legal fictions and state-law labels must yield to the economic substance of the arrangement:

"Labels are perhaps least relevant because they may be inconsistent with the economic reality of a partner’s relationship with the entity... A partner labeled a limited partner who works for the business full time, whose work is essential to generating the business's income, who is held out to the public as essential to the business, and who contributes little or no capital, is not functioning as a limited partner regardless of the label placed on that partner."

The Appeal Before the Second Circuit: The Core Issues

Following the Tax Court's final decision, Soroban appealed to the U.S. Court of Appeals for the Second Circuit under docket number 25-2079. Represented by Shay Dvoretzky, Soroban presented two primary issues to the appellate panel consisting of Judges Guido Calabresi, Denny Chin, and Sarah A.L. Merriam:

The Jurisdictional Issue: Whether the Tax Court lacked jurisdiction under TEFRA to adjust self-employment taxes at the partnership level. The appellant argues that under I.R.C. Section 6231(a)(3), a partnership item must be "required to be taken into account for the partnership's taxable year" under Subtitle A. Because self-employment tax is an individualized, partner-level tax imposed on individuals under Section 1401, nothing in Subtitle A requires the partnership itself to take net earnings from self-employment into account for its own taxable year.
The Substantive Issue (The Merits): Whether the Tax Court erred in holding that Section 1402(a)(13) does not automatically exempt any partner who holds the legal status of a "limited partner" under state law. The appellant contends that when Congress codified the exception in 1977, the term "limited partner" had a plain, uniform meaning under state law—namely, a member of a limited partnership who enjoyed limited liability. The appellant argues that federal tax law must respect this state-law property right and cannot rewrite the statute to insert a participation-based "functional analysis" test.

Key Judicial Concerns in the Appellate Oral Arguments

The oral arguments before the Second Circuit panel featured intense questioning of both Shay Dvoretzky (for Soroban) and Norah Bringer (for the Commissioner). Each judge focused on distinct legal, historical, and practical aspects of the controversy.

Jurisdictional Limits and Administrative Inconsistency

Judge Denny Chin opened the jurisdictional debate by questioning how the self-employment tax could be administered efficiently if it were not resolved at the partnership level. He pressed the appellant:

“..[I]f this were done on the partner by partner level, couldn't that lead to inconsistent results? And wasn't the whole point of the statutory system to avoid that problem?"

The appellant admitted that TEFRA was designed to promote efficiency and avoid inconsistency, but argued that this policy only extends to items that are legally categorized as partnership items in the first place. Dvoretzky emphasized that "net earnings from self-employment is an individualized determination" that does not belong on a partnership return and does not appear on the regulatory list of partnership items, making it an affected item that must be determined in partner-level deficiency proceedings.

State Law Designations versus Federal Tax Uniformity

Judge Guido Calabresi raised a profound constitutional and statutory concern regarding whether federal tax law can blindly defer to state-law definitions of partnership status. He noted that if federal tax liability is tied strictly to state-law labels, individual states could unilaterally alter the federal tax base by amending their partnership statutes, leading to geographic disuniformity. He asked the appellant:

"Are you saying that then individual states can by changing their law make the federal tax law be different?"

To illustrate the absurdity of complete deference to private or state-law labeling, Judge Calabresi introduced a hypothetical:

"I recently won the Philips Prize from the American Philosophical Society. Turns out that's taxable and it's taxable to me individually. Suppose the philosophical society were to say every winner of that prize is actually a limited partner in the society. Do they have that capacity to change federal tax law on the basis of individual states? Does that make any sense?"

The appellant responded that states are not rewriting federal tax law. Rather, federal tax law frequently looks to state law to define the underlying legal relationships, rights, and obligations (such as the validity of a marriage, which varies from state to state). Dvoretzky argued that the "common thread" in 1977 was simply that a limited partner was a member of a limited partnership who enjoyed limited liability under state law, and that federal law appropriately references those state-created rights.

Historical Definition and the Role of Control

Judge Sarah A.L. Merriam focused heavily on the historical legal context of 1977, arguing that when Congress enacted the limited partner exception, state-law limited partners were legally prohibited from actively managing or controlling the partnership. She pointed out that under the 1916 Uniform Limited Partnership Act (ULPA), which was in force in 49 states in 1977:

"limited partners are not bound by the obligations of the partnership... section four says the contributions of a limited partner may be cash or property but not services and section seven says a limited partner can become liable as a general partner... if he takes part in the control of the business."

Judge Merriam argued that under the historical framework, the Soroban Principals would not have been legally permitted to act as limited partners while exercising complete managerial control:

"How does that not say that the partners in this case are not limited partners... the vast majority require that a limited partner not participate in the management or control... the vast majority of historical sources require that a limited partner not participate in the management or control."

The appellant responded by distinguishing between the status of a limited partner and the consequences of exercising control under state law. Dvoretzky argued that under the 1916 ULPA, a limited partner who exercised control did not lose their "limited partner" status or become transformed into a general partner; rather, they merely lost their liability shield with respect to creditors. He cited the existence of dual-status partners (who simultaneously hold both general and limited partner interests) to prove that having unlimited liability does not strip away a partner's limited partner capacity.

Administrability and the Specter of an Amorphous Control Test

Judge Calabresi expressed deep concern regarding the practical administrability of the IRS's position. He warned that adopting a vague, multi-factor "functional analysis" test based on "control" would create massive complexity and compliance uncertainty for ordinary taxpayers who do not have the resources of a multi-billion-dollar hedge fund:

"If we buy what you suggest, aren't we creating a situation which is incredibly difficult for individual taxpayers because the question of what is sufficient control or not varies greatly and so the tax liability of individuals would become an immensely complicated one... wouldn't we, if we buy your position, create a situation which really makes administration and fairness to individuals extremely difficult?"

The Commissioner's counsel, Norah Bringer, countered that multi-factor "facts-and-circumstances" tests are a standard and manageable feature of the tax code, pointing to the Supreme Court's decisions in Commissioner v. Tower and Commissioner v. Culbertson regarding partnership validity. Bringer argued that the Supreme Court itself stated "there is nothing new or particularly difficult about such a test." She also drew an analogy to the highly complex, facts-and-circumstances analysis required to distinguish debt from equity when taxpayers "push the boundaries of where the line is."

The appellant strongly disputed this during rebuttal, arguing that unlike the intent-based test in Culbertson which is evaluated once at inception, a partner's level of control can change continuously over time, requiring a highly burdensome, year-by-year, partner-by-partner re-evaluation.

Guaranteed Payments and Apportionment

Judge Chin also raised a practical question regarding how Soroban determined and reported its guaranteed payments, noting that the partners received approximately $2 million in guaranteed payments but excluded $140 million in distributive shares. He asked:

"Does the record indicate how they apportioned the guaranteed amount which was, what, 2 million or something from the other amounts?"

The appellant admitted he did not know the answer from the record. Judge Chin then observed that the sheer volume of services performed by the Principals made it hard to argue they were passive, stating:

"I mean the suggestion is they acknowledge some work and that's true with the guaranteed payment but it seems that they did a lot of work. I mean as council for the other side argues, it's not a close case."

The appellant conceded that while it may not be a close case under the IRS's "amorphous" control test, it is also "not a close case in the other direction" because under Delaware law, these partners were legally entitled to limited liability.

The Tax Landscape and Broader Implications for Practitioners

The Second Circuit's eventual ruling in Soroban will have massive ramifications for the asset management industry and broader partnership tax compliance. If the Second Circuit affirms the Tax Court on both jurisdiction and the merits, it will solidify the IRS's authority to use a functional analysis to dismantle SECA exclusions for active partners in state-law limited partnerships.

Currently, the judicial landscape is highly fractured:

The Fifth Circuit: Has recently issued a ruling on the merits in favor of the taxpayers, but a petition for rehearing has been filed, and the court has held the mandate pending further review.
The First Circuit: A similar case, Denham Capital Management LP v. Commissioner, is currently pending, with practitioners eagerly awaiting an opinion.
Administrative Exams: The IRS is actively pursuing these issues in audits and examinations of hedge funds, private equity funds, and other service-heavy limited partnerships.

For CPAs and EAs, these developments dictate a proactive and cautious approach:

Evaluate Operational Realities: Advisers must look past the "limited partner" label in the partnership agreement. If a client is a limited partner but works full-time in the business, serves on management committees, or holds key-man status, their distributive share is highly vulnerable to SECA tax.
Document and Apportion Services: Partnerships should carefully document the capital-intensive versus service-intensive portions of their business. While Soroban represents an extreme case of service-only income ($247 million in management and performance fees on virtually zero capital), partnerships with significant capital-generating assets must establish a clear economic link between their distributive shares and their capital accounts to defend a partial SECA exclusion.
Audit Exposure and Disclosure: Clients must be briefed on the high audit risk associated with active-partner SECA exclusions. Depending on the jurisdiction, practitioners should consider whether a Form 8275 or 8275-R Disclosure Statement is warranted to mitigate accuracy-related penalties.

Prepared with assistance from NotebookLM.