The IRS issued temporary regulations in May clarifying that partners in a partnership entity cannot be treated as employees of the partnership. Some partnerships currently treat partners as employees of a disregarded entity owned by the partnership and allow them to receive tax benefits and other employee benefits, such as participation in cafeteria plans.
What you need to know
Entities must comply with the new ruling by Aug. 1, 2016 or on the first day of the latest-starting benefit plan year following May 4, 2016, whichever is later. However, the IRS is also asking for comments on when it might be appropriate to allow partners to be employees of a partnership, so there could be additional flexibility in the future.
Currently, the IRS specifically prohibits partners from being employees of a disregarded entity owned by the partnership. This includes the following areas in which partners must be handled differently than employees:
- Withholding income tax
- Withholding FICA tax
- Self-employment taxes
- Treatment of health, welfare and fringe benefits
- Cafeteria plans
Treating partners as employees can cause issues for both the partner and the partnership entity, including under or overpayment of employment taxes for the partner, complete disqualification of a cafeteria plan, failure of an unvested partnership interest to qualify for safe harbor tax treatment, and inaccurate employment reporting for purposes such as Affordable Care Act calculations.
As companies find ever more creative ways to recruit and retain key talent, including granting small or large partnership interests, it becomes more important for taxpayers to understand the critical difference in how partners and employees are treated for tax and other purposes.
For a more detailed analysis of this topic, see our white paper here.
For more information, contact your AGH tax professional or AGH senior vice president of tax services Shawn Sullivan using the information below.
NOTE: Any advice contained in this material is not intended or written to be tax advice, and cannot be relied upon as such, nor can it be used for the purpose of avoiding tax penalties that may be imposed by the IRS or states, or promoting, marketing or recommending to another party any transaction or matter addressed herein.
Senior Vice President
Shawn serves as one of two primary leaders in the firm’s large tax group. He has extensive public and private experience in the fields of tax and accounting and works frequently with clients in the manufacturing, wholesale/retail distribution, real estate development and management, construction, and contractor industries. In addition to enhancing business performance to minimize tax consequences, he has experience in mergers and acquisitions and international tax and business structuring.
A certified public accountant, Shawn is a member of the American Institute of Certified Public Accountants, the Kansas Society of Certified Public Accountants (KSCPA) and chairs the KSCPA Committee on Taxation.