OUR THOUGHTS ON:

Employee or Partner? Treatment of Individuals within Partnerships Owning Disregarded Entities

Human Resources|Tax

By Colin Sherwin

For many years, some partnerships that owned disregarded entities (single-member LLCs) claimed that their partners were employees of the single-member LLC to minimize self-employment taxes and participate in tax-favored benefit plans.  However, recent temporary regulations issued by the Treasury have brought this topic into focus.  These regulations may have a significant impact on partnership structures because of the self-employment tax consequences that could result.

The regulations treat a disregarded entity as a corporation for employment tax purposes, but not for self-employment tax purposes.  Therefore, the individual partners in the partnership owning the disregarded entity are subject to self-employment tax on the net earnings resulting from the disregarded entity’s activities.  Because partners of the partnership own the single-member LLC, the regulations look-through the partnership and treat partners as self-employed individuals subject to self-employment tax.

Once the partners lose their treatment as employees of the single-member LLC, there can be various disadvantages.  First, self-employment tax will be levied at 15.3% on the disregarded entity’s net earnings, due to the individual being liable for paying both the employee and employer portion of Social Security and Medicare taxes, which may necessitate a change in payroll reporting obligations for the employee partners.  Second, if the partners are classified as self-employed, restrictions on participation tax-favored employee benefit plans such as cafeteria and retirement plans may apply.  For these purposes, an affected plan includes any qualified plan, health plan, or Section 125 cafeteria plan if the plan benefits participants whose employment status is affected by the regulations.

The Treasury has set an effective date that will allow sufficient time for partnerships to effectively address changes to payroll and employee benefit plans.  The temporary regulations will be applied August 1, 2016 or the first day of the latest starting plan year following May 4, 2016 of an affected plan sponsored by an entity that is disregarded as an entity separate from its owner. 

Contact Schneider Downs for more information about the article above or visit our Our Thoughts On blog for more articles related to this topic.

You’ve heard our thoughts… We’d like to hear yours

The Schneider Downs Our Thoughts On blog exists to create a dialogue on issues that are important to organizations and individuals. While we enjoy sharing our ideas and insights, we’re especially interested in what you may have to say. If you have a question or a comment about this article – or any article from the Our Thoughts On blog – we hope you’ll share it with us. After all, a dialogue is an exchange of ideas, and we’d like to hear from you. Email us at contactSD@schneiderdowns.com.

Material discussed is meant for informational purposes only, and it is not to be construed as investment, tax, or legal advice. Please note that individual situations can vary. Therefore, this information should be relied upon when coordinated with individual professional advice.

© 2018 Schneider Downs. All rights-reserved. All content on this site is property of Schneider Downs unless otherwise noted and should not be used without written permission.

comments