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.

Similar Articles
Relevancy Powered by MondaqAI
Ostrow Reisin Berk & Abrams
In association with
Related Topics
Similar Articles
Relevancy Powered by MondaqAI
Ostrow Reisin Berk & Abrams
Related Articles
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
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

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 or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq 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 of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions