Fifth Circuit on Rehearing Makes the Same Mistake on the Limited Partner Gambit to Avoid Tax (8/13/26; 8/20/26)

On 8/20/26 at 12:25 am, I substantially revised this blog entry. My additions are indicated in red; but I do not show strikeouts.

In Alain, L.L.L.P. v. Commissioner, ___ F.4th ___ (5th Cir. 8/12/26), CA5 here; GS here, the Court on panel rehearing (also denying en banc rehearing), again rejected the Tax Court and IRS interpretation of the limited partner exception to the “self-employment income” in § 1402(1)(13). Readers paying attention in the tax procedure universe are surely familiar with that issue. Basically, active service participants in a business enterprise who would have had self-employment income in straight-forward characterization of their earnings have tried to avoid that tax on self-employment income by the magic of labeling their income as a distributive share for share for limited partners.

Alain was originally decided in Sirius Solutions, L.L.L.P. v. Commissioner, 165 F.4th 374 (5th Cir. 2026), GS here, which the Court withdrew on the rehearing. The judges on the panel rendered opinions to the same effect as before. The Sirius majority opinion was nominally authored by Judge Oldham. The panel rehearing opinion is per curiam with neither of the majority judges stepping up as the author.

I critiqued the majority in Sirius Solutions in Fifth Circuit Knows a Limited Partner When Reads It (Federal Tax Procedure Blog 1/24/26; 1/20/26), here. In my original blog on Alain, I did not pay attention to the difference between the original opinion in Sirius and the revised opinion in Alain. The panel majority states its bottom-line interpretation in the opening (Slip Op. 1): 

Today, we hold its original public meaning is a partner who plays no significant role in managing or running a business.

As stated, the panel majority’s revised formulation narrows the limited partner exception it approved in its earlier opinion. The panel majority deploys the tools of interpretation that textualists so love (such as contemporary dictionaries) to determine (divine) the original public meaning to possibly include only a smaller subclass of nominal “limited partners”—specifically those limited partners who have no significant role in managing or running the business. That narrowing is at least an improvement on the earlier opinion. 

Judge Graves engages the majority on its determination of original public meaning. (Slip Op. 21-25.)

JAT Conclusion: I am not sure that the panel majority formulation materially differs from the Tax Court’s functional analysis approved by the Tax Court. Let’s do some what-iffing to set the parameters:

Suppose a “limited partnership” which includes, among others, Partners A and B. Partner A owns significant LP units (say 1,000) and performs material investment-related services (such as picking the investments, choosing the functional employees of the business, and fronting the partnership in beauty contests for prospective investors); Partner B owns 1 unit and is the secretary to the person employed by the corporate general partner who is the top manager of the business but otherwise performs no significant services other than secretarial services that could be obtained in the marketplace for secretarial services at the overall actual compensation for such services that the partnership pays her. Both Partner A and Partner B made their initial (and only) partnership contribution at a valuation of $1,000 per unit. Partner A’s so-called “distributive share (relative to LP units) would not qualify for the limited partner exception; Partner B’s would seem to qualify. I set aside whether the per-unit initial costs were undervalued that might raise the service partner compensation issue and assume that hypothetical liquidation of the limited partnership at the inception would not have returned to the nominal limited partners any amount exceeding their respective original contributions. I think I can reasonably speculate that, in this simple (perhaps simplistic) example, Partner A’s distributive share would not qualify for the limited partner exception, whereas Partner A’s distributive share would. (I suppose an argument might be made that one unit of Partner A’s distributive share might qualify, but don’t go down that rabbit hole now.)

Of course, there will be different fact patterns involving different relative services provided to the limited partnership’s active service business. When will that relative mix make a difference under either the Tax Court’s functional analysis or the Alain panel majority’s test is yet to be known. It seems to me that in the most abusive cases (with nominal limited partners more like Partner A than Partner B), the IRS should prevail.

This case should be subject to Gregory v. Helvering analysis. Helvering v. Gregory, 69 F.2d 809, 810 (2d Cir. 1934) (L. Hand), GS here, which, after making an iconic statement there is no duty, patriotic or otherwise, to pay more tax than is due, but then said: “Nevertheless, it does not follow that Congress meant to cover such a transaction, not even though the facts answer the dictionary definitions of each term used in the statutory definition.” Then, the Supreme Court said much the same thing on certiorari in Gregory v. Helvering, 293 U.S. 465, 470 (1935), here: 

          In these circumstances, the facts speak for themselves and are susceptible of but one interpretation. The whole undertaking, though conducted according to the terms of [the reorganization statute], was in fact an elaborate and devious form of conveyance masquerading as a corporate reorganization, and nothing else. The rule which excludes from consideration the motive of tax avoidance is not pertinent to the situation, because the transaction upon its face lies outside the plain intent of the statute. To hold otherwise would be to exalt artifice above reality and to deprive the statutory provision in question of all serious purpose.

The panel majority on the original opinion was wrong; the panel majority's rehearing opinion is less wrong than the original opinion. 

I apologize to readers on missing the key point on the original blog on Alain.