By Sally P. Schreiber, J.D.

May 3, 2016

The IRS issued temporary regulations on Tuesday intended to halt the practice some partnerships have adopted of treating partners as employees of a disregarded entity owned by the partnership so they could be included in employee benefit plans and receive other benefits (T.D. 9766). However, the IRS is also asking for comments on when it might be appropriate to allow partners to also be employees of a partnership.

To give taxpayers time to implement the new rules, the IRS is allowing any plan sponsored by an entity that is disregarded as an entity separate from its owner to apply them on Aug. 1, 2016, or the first day of the latest-starting plan year following May 4, 2016, whichever is later.

Under Regs. Sec. 301.7701-2(c)(2)(iv)(B), a disregarded entity is treated as a corporation for employment tax purposes, meaning that the entity, rather than its owner, is treated as the employer of the entity’s employees. However, this rule does not apply for self-employment tax purposes, so the owner of an entity that is treated as a sole proprietorship is subject to self-employment tax.

The regulations include an example in which the owner of the disregarded entity is an individual who is subject to self-employment tax on the net earnings from the disregarded entity’s activities. The regulations do not provide an example in which the disregarded entity is owned by a partnership.

Some taxpayers have taken the position that where a partnership is the sole owner of a disregarded entity, partners in the partnership can be treated as employees of the disregarded entity because the regulations did not include a specific example applying the rule in the context of a partnership. Treating the partners as employees of the disregarded entity allows them to participate in certain employee-benefit plans.

In the preamble to Tuesday’s temporary regulations, the IRS explains that the holding of Rev. Rul. 69-184 is still in effect. That ruling stated that (1) bona fide members of a partnership are not employees of the partnership for purposes of Federal Insurance Contributions Act, the Federal Unemployment Tax Act, and income tax withholding, and (2) a partner who devotes time and energy in conducting the partnership’s trade or business, or who provides services to the partnership as an independent contractor, is considered self-employed and is not an employee.

The preamble notes that the IRS did not intend to “create a distinction between a disregarded entity owned by an individual (that is, a sole proprietorship) and a disregarded entity owned by a partnership in the application of the self-employment tax rule.” Rather, the general rule making the owner of an entity that is treated as a sole proprietorship subject to self-employment tax applies for any owner of a disregarded entity—there is no exception for partnerships.

Therefore, the IRS explicitly clarifies in the preamble that “the rule that a disregarded entity is treated as a corporation for employment tax purposes does not apply to the self-employment tax treatment of any individuals who are partners in a partnership that owns a disregarded entity.”

The IRS is considering issuing rules that would permit tiered partnerships, in some circumstances, to treat partners as employees of the partnership and is asking for comments on the impact on employee benefit plans (including qualified retirement plans, health and welfare plans, and fringe benefit plans) and on employment taxes if the IRS were to modify Rev. Rul. 69-184 to permit partners to also be employees in certain circumstances and also what those circumstances might be.

Editor’s note: For background on this topic, see Brock, “Partners as Employees? Properly Reporting Partner Compensation,” The Tax Adviser (Nov. 1, 2013).

—Sally P. Schreiber ( is a Tax Adviser senior editor.

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Partnership tax terms and what they mean

Puzzled by tax-related partnership lingo?  Here’s the definition of key terms in partnership tax rules/

  • Guaranteed payments. Payments made to partners during the year regardless of whether the business is profitable.
  • Schedule K-1. The tax form used to report items of income, loss, and partnership activities to partners.
  • Limited liability company (LLC). A legal business entity, similar to a partnership, where the members have no personal obligation to pay company debts.
  • Partner. One of the individual parties in a partnership.
  • Partnership. An unincorporated business made up of two or more entities who engage in an activity for profit. Income and loss of the partnership are passed through to the partners.  For tax purposes, a partnership may differ from a joint venture, which generally a joint undertaking to share expenses.
  • Partnership agreement. A legally binding agreement between partners detailing the business relationship. Amendments are considered part of the original agreement.