That a partner is not an employee is not new. The IRS has held this position for almost fifty years,[1] but a regulation[2] recently issued makes it clear that nothing has changed.
The Service has maintained a rather lax attitude for many years when a partnership treats one of its partners as an employee, reporting compensation for services as wages on form W-2 rather than as a guaranteed payment on schedule K-1. Companies may do this simply out of convenience, either for the partnership or the partner, enabling personal income tax, social security tax and Medicare tax to be paid by the partnership instead of by the partner making estimated tax payments. The amount of tax paid to the IRS is the same, although, some inequity may result among the partners if not all of the partners are providing services.[3]
The more significant distinction between wages and guaranteed payments relates to the many tax-advantaged employee benefits that are allowed to the partnership’s employees but not to partners providing services to the partnership. Parity has been allowed for certain fringe benefits[4], and retirement contributions.[5] However, partners are not considered employees for purposes of participation in cafeteria plans,[6] the exclusion for meals and lodging furnished for the convenience of the partnership/employer,[7] the exclusion of life insurance premiums,[8] and group health benefits. While a partner can secure health benefits as a self-employed individual, payment through the company’s plan for its employees may be problematic if not explicitly treated as a guaranteed payment or partnership distribution. What’s more, tax advisors are concerned about whether the participation of a partner in a section 125 cafeteria plan may jeopardize the plan in general.
The regulation bringing this issue into focus was aimed at a too-clever[9] “workaround” to make such benefits available to partners through a disregarded entity. The regulation soundly denied this and re-affirmed its support of Rev. Rul. 69-184, noting that the effective date allows adequate time for partnerships to make necessary payroll and benefit plan adjustments.[10]
Partnerships not availing themselves of this “workaround” should still heed the warning that enforcement of Rev. Rul. 69-184 is to be expected going forward.
[1] Rev. Rul. 69-184.
[2] Treasury Decision 9766, Temp. Reg. Sec. 301.7701-2T.
[3] The employer portion of social security tax is paid and deducted by the partnership in the case of wages. If the compensation is reflected as a guaranteed payment, the partner would be responsible for self-assessing this amount as part of the tax on self-employment income. In this case the partner would pay the “employer” tax and take the deduction on his own return, rather than sharing the cost and deduction with his partners.
[4] IRC section 132.
[5] IRC section 401(c)(4).
[6] IRC section 125.
[7] IRC section 119.
[8] IRC section 79.
[9] “Pigs get fat, hogs get slaughtered.”
[10] Treasury Decision 9766, Temp. Reg. Sec. 301.7701-2T. Temporary regulations apply on the later of August 1, 2016 or the first day of the latest-starting plan year following May 4, 2016.
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