Partners are Not Employees, Even of the Partnership’s LLC

Partners are Not Employees, Even of the Partnership’s LLC

      It is an axiom of the law of partnerships, irrespective of whether your perspective is that of state law or tax law, that one who is a partner is treated as an owner and not as an employee. It is for this reason, for example, that partners are not covered by Title VII and that they report the income received from a partnership as self-employment income. The same rule applies in LLCs that are treated as partnerships; each member is treated as being self-employed.

      One structure that has been utilized by partners seeking to convert their status, at least in part, into that an employee has been to have the partnership organize a single member LLC (“SMLLC”) and for at least certain of the partners in that partnership to then claim to be employees of that SMLLC. In that the SMLLC is treated as a disregarded entity (and not a partnership) for tax purposes, those partners asserted that they may be employees without running afoul of the rule that partners are not employees.

      The IRS, in recently released regulations (T.D. 9766, May 3, 2016), has put a stop to this practice. Essentially, the structure was arguably permissible only because it was not addressed in certain of the examples provided with respect to the rules for employment taxes with respect to disregarded entities. In the commentary released with the new regulations, the Service made clear that simply because a fact situation is not discussed in the examples, it does not fall outside the scope of the substantive regulations. In turn, the substantive regulations make clear that the owner of a disregarded entity is not an employee with respect thereto, but rather is self-employed. In turn, if a partnership owns an SMLLC that is disregarded for tax purposes, and a partner in that partnership render services on behalf of the SMLLC, any distributions made with respect thereto are self-employment income.

      Because these structures were oft put into place in order to take advantage of certain employee benefit plans (e.g., cafeteria plans) and there needs to be significant time in order to “unwind” those structures, the delayed effective date runs into 2019. However, for transactions not involving a plan, the new regulations are effective August 1, 2016.

     HERE IS A LINK to the regulations and the related release.