The IRS has long taken the position that partners cannot be employees of their own partnership (Rev. Rul. 69-184). Instead, a partner that provides services to their partnership is treated as self-employed and their earnings are subject to self-employment taxes. However, in the past, some taxpayers set up a single-member limited liability company (SMLLC)* as a workaround to this rule. This newly formed SMLLC would be 100% owned by their partnership and would be the employer. While the SMLLC is not treated as a separate entity for income tax filing purposes, it had been treated as its own corporation for payroll tax purposes only.
In May of 2016, the IRS issued regulations that served to clarify their position – partners were not intended to and will no longer be eligible for employee treatment in the SMLLC, but will also be treated as if they were self-employed by that SMLLC. These regulations are effective on the later of: 1) August 1, 2016 or 2) the first day of the latest-starting plan year following May 4, 2016, of an affected plan.
If your partnership is still utilizing the SMLLC structure to classify partners as employees please contact your GBQ tax advisor to discuss your options.
* A SMLLC is an entity that is owned 100% by another taxpayer and is therefore disregarded for federal income tax purposes, which means they don’t have their own federal tax return filing requirement. Instead, you simply include their activity on the owner’s federal return. For instance, partnership A owns 100% of SMLLC B – all of B’s income, expenses, etc. are included in partnership A’s federal tax return and SMLLC B does not file a federal tax return with the IRS.
Note – Rev. Rul. 69-184 does not apply to tiered partnership structures. However, be advised that the IRS is looking at this issue and has requested comments on the applicability of Rev. Rul. 69-184 to tiered partnerships.