United States: IRS Moves To Bar Partners From Employee Treatment

The IRS has released temporary and proposed regulations that bar partners from being treated as employees of a disregarded entity (DRE) owned by their partnership.

The temporary regulations (T.D. 9766) will require a relatively quick response from taxpayers regarding the employment tax treatment of certain partners, their eligibility for benefit plans and the qualifying status of the benefit plans themselves. They are effective on the first day of the latest-starting new employee benefit plan year following May 4, 2016, or by Aug. 1, 2016, if later. The temporary regulations were issued concurrently as proposed regulations (REG-114307-15) to allow taxpayers to comment.

Treatment of partners as employees

The question of whether an individual holding a partnership interest can ever be treated as an employee of the partnership has long been considered by taxpayers. The determination is important for various tax rules, and partners face significant restrictions on employee benefits.

Most of the case law and guidance generally provides that even a nominal partnership interest disqualifies an individual from employee treatment. In 1967, The U.S. Court of Claims in Wilson v. United States stated that a partnership is not a legal entity separate and apart from its partners, and "accordingly, a partnership cannot be regarded as the employer of a partner for the purposes of [the exclusion from income for meals and lodging]." The IRS followed with two general counsel memoranda in 1969 (GCM 34001 and GCM 34173), which generally found that a person cannot be both employer and employee and that it is therefore not possible to be an employee of a partnership in which one is a partner. In an isolated case from the Fifth Circuit, the Court of Appeals held in 1968 in Armstrong v. Phinney that a person could have dual status as an employee and partner for purposes of the exclusion of meals and lodging from income.

Most importantly, the IRS issued Rev. Rul. 69-184, concluding that, for purposes of employment tax provisions (Federal Insurance Contributions Act (FICA), Federal Unemployment Tax Act (FUTA) and withholding from wages), a partner can be treated as an independent contractor for certain services under Section 707, but the partner can never be treated as an employee. The IRS has steadfastly continued to abide by Rev. Rul. 69-184.

Despite very little apparent support for the position in the record, some taxpayers have argued that a nominal interest in a partnership should not disqualify an individual from employee status. In addition, taxpayers have recently taken the more aggressive position that the regulations regarding DREs, which generally treat a DRE as a corporation for employment tax purposes, allow partners employed by a partnership's DRE to be treated as employees of the DRE.

DREs and the new regulations

The classification regulations under Section 7701 generally provide that a business entity that has a single owner and is not a corporation is disregarded, and not considered separate from its owner. However, in 2007, the regulations were amended to provide an exception for employment taxes. Under this rule, a DRE is respected and treated as a corporation for reporting and remitting employment taxes, but not for the application of self-employment taxes.

The IRS said in the preamble to the new temporary regulations that taxpayers have been using the 2007 employment tax regulations, including an example, to take the position that partners can be treated as employees of a DRE owned by a partnership even though the DRE is generally disregarded for federal tax purposes.

The new regulations clarify that a DRE cannot be treated as a corporation for purposes of employing any partner of a partnership. The rule that respects a DRE as a separate corporation for employment tax purposes does not apply to the self-employment tax treatment of partners. So a partnership's DRE is effectively disregarded for all partners under the new rules, and the partners in the partnership are subject to the same self-employment tax rules as partners in a partnership that does not own a DRE. The new regulations preclude the partners from participating as employees in any of the DRE's benefit plans, although the partners can still participate in their partner capacity as long as the plan is a type that allows participation by partners under federal income tax law.

The regulations expressly avoid addressing the application of Rev. Rul. 69-184 to tiered partnership structures, which will remain subject to some uncertainty. The IRS also noted that taxpayers have asked the IRS to modify Rev. Rul. 69-184 to allow employees of partnerships to receive nominal partnership interests as awards or incentives without losing their employee status. The IRS asked for comments on both of these issues.

Next steps

Any partnership that treats partners as employees through a DRE should immediately begin planning to correct this treatment by the effective date of the new regulations. Partners will no longer be permitted to receive W-2 wages from a DRE owned by their partnership under the new rules, and these DREs should no longer perform withholding. All payments should be treated and reported on a partner's Schedule K-1 as partnership distributions or guaranteed payments subject to estimated taxes and self-employment taxes to the extent those rules apply.

Partnerships should also immediately begin planning to make all affected benefit plans compliant after the recharacterization of affected employees as partners. This entails identifying plans in which partners are not permitted to participate under federal income tax law, such as Section 125 cafeteria plans, and ceasing partners' participation in the plans. In addition, it involves identifying plans in which partners are permitted to participate under federal income tax law and making sure the plan documents explicitly provide for participation by partners. These plans include any qualified retirement plans and health plans. The consequences of failing to comply with benefit plan compliance can be severe. 

Tax professional standards statement

This content supports Grant Thornton LLP's marketing of professional services and is not written tax advice directed at the particular facts and circumstances of any person. If you are interested in the topics presented herein, we encourage you to contact us or an independent tax professional to discuss their potential application to your particular situation. Nothing herein shall be construed as imposing a limitation on any person from disclosing the tax treatment or tax structure of any matter addressed herein. To the extent this content may be considered to contain written tax advice, any written advice contained in, forwarded with or attached to this content is not intended by Grant Thornton LLP to be used, and cannot be used, by any person for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

In association with
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.