In a recent treasury decision (TD 9766, NPRM REG-114307-15) the IRS has issued final, temporary and proposed regs that preserve a
partner’s status as a partner, and not an employee. In this decision, the partner
worked for a disregarded entity that was also owned by the partnership. The regulations settled herein are
said to be consistent with Rev. Rul. 69-184,
which concluded that members of a partnership are not employees of the
partnership, even if they devote time to the partnership’s trade or
business or provide services to the partnership as an independent
contractor.
The government, however, correctly noted in
its discussions that it still needs a significant amount of outside
assistance (particularly in the employee benefits area) to get
comfortable with any such exception to the ‘partner-only’ treatment of
persons who hold an equity interest (no matter how small) in a tax
partnership and who also provide services to such partnership." For example, it seems, certain members who hold say very small (incentive) amounts of an interest in the entity and who actually provides services to the entity might actually be considered as employees. However, those situations are rare (see also Rev Ruling 69-184).
Treatment of Disregarded Entities (one-member LLCs) and Partners
An
entity, such as a limited liability company, with a single owner is
treated as a DE (assuming the entity did not elect to be treated as a
corporation). Ordinarily, the DE is disregarded as an entity separate
from its owner and is treated like a sole proprietorship, with the DE’s
income and deductions attributed to the owner. However, for employment
tax purposes, the IRS amended its regs previously so that a DE is
treated as a corporation and is considered to be the employer of its
employees. The owner of the DE is not treated as the employer.
At
the same time, the owner of the DE is treated as self-employed and must
pay self-employment tax on the DE’s earnings. Thus, for the owner’s
self-employment purposes, the entity continues to be disregarded from
the owner.
There
is no distinction between a DE owned by an individual and a DE owned by
a partnership. In fact, the current regulations do not discuss a DE that is
owned by a partnership. Because a DE is treated as the employer of its
employees, some partners have interpreted the current regs to permit
individual partners to be treated as employees, if the partners provide
services to a DE, even a DE owned by the partnership. Under this
interpretation, partners have been treated as employees of the DE and
have been allowed to participate in the
partnership’s employee benefit plans. This
interpretation was not intended, the IRS indicated. There is no
exception in the self-employment rules for a partnership that owns a DE.
The IRS also affirmed that the regulations do not alter Revenue Ruling 69-184, which requires that partners providing services be treated as self-employed.
The New Regulations
The temporary regulations "clarify"
that the rule treating a DE as a corporation for employment tax
purposes does not apply to the employment tax treatment of individuals
who are partners of a partnership that owns a DE. The entity continues
to be disregarded from the partners for self-employment tax purposes,
and the partners are still subject to self-employment tax as partners of
a partnership. The partners are treated no differently from partners of
a partnership that does not own a DE.
The
regulations will not apply until the later of (1) August 1, 2016, or (2) or
the first day of the latest-starting plan year after May 4, 2016, for an
"affected" plan sponsored by a DE. Affected
plans include qualified plans, health plans, and cafeteria plans. This
effective date gives partnerships time to make payroll and benefit plan
adjustments.
Finally Regarding Rev. Rul. 69-184
The regs do not address Rev. Rul. 69-184
and tiered partnerships. The IRS reported that stakeholders have
requested guidance in this situation and, also, where employees of a
partnership receive a small partnership interest as compensation. The
IRS requested comments on the appropriate application of Rev. Rul. 69-184
in these situations, including when it would be appropriate to treat
partners as employees, and the impact on employee benefit plans and on
employment taxes.
References: CCH FED Paragraphs 47,024 and 49,696.
