Temporary regulations prohibit partners from being employees.

• Author: Schreiber, Sally P.

The IRS issued temporary regulations intended to halt the practice some partnerships have adopted of treating partners as employees of a disregarded entity owned by the partnership so they could be included in employee benefit plans and receive other benefits (T.D. 9766). However, the IRS is also asking for comments on when it might be appropriate to allow partners to also be employees of a partnership.

To give taxpayers time to implement the new rules, the IRS is allowing any plan sponsored by an entity that is disregarded as an entity separate from its owner to apply them on Aug. 1, 2016, or the first day of the latest-starting plan year following May 4, 2016, whichever is later.

Under Regs. Sec. 301.7701-2(c)(2) (iv)(B), a disregarded entity is treated as a corporation for employment tax purposes, meaning that the entity, rather than its owner, is treated as the employer of the entity's employees. However, this rule does not apply for self-employment tax purposes, so the owner of an entity that is treated as a sole proprietorship is subject to tax on self-employment income.

The existing regulations included an example in which the owner of the disregarded entity is an individual who is subject to self-employment tax on the net earnings from the disregarded entity's activities. The regulations did not, however, provide an example in which the disregarded entity is owned by a partnership.

Some taxpayers have taken the position that where a partnership is the sole owner of a disregarded entity, partners in the partnership can be treated as employees of the disregarded entity because the regulations did not include a specific example applying the rule in the context of a partnership. Treating the partners as employees of the disregarded entity allows them to participate in certain employee-benefit plans.

In the preamble to the temporary regulations, the IRS explains that the holding of Rev. Rul. 69-184 is still in effect. That ruling stated that (1) bona fide members of a partnership are not employees of the partnership for purposes of the Federal Insurance...