The Treasury Department and IRS today released for publication in the Federal Register temporary regulations (T.D. 9766), and by cross-reference, proposed regulations (REG-114307-15) that are intended to clarify the employment tax treatment of partners in a partnership that owns a disregarded entity.
Current regulations provide that a disregarded entity is treated as a corporation for employment tax purposes and provide an exception to that treatment in the case of a disregarded entity that is treated as a sole proprietorship. In the case of the sole proprietorship, the owner of the disregarded entity is subject to tax on self-employment income. An example illustrates the exception. Taxpayers have interpreted the language of the regulations to allow partnerships that own a disregarded entity (treated as a corporation) to treat partners as employees of disregarded entity.
Today’s regulations were promulgated in proposed and temporary form, with a liberal effective date, to address the employment tax classification of a disregarded entity owned by a partnership.
The temporary and proposed regulations clarify that a disregarded entity that is generally treated as a corporation for purposes of employment taxes is not treated as a corporation for purposes of employing its individual owner (who is treated as a sole proprietor) or for purposes of employing an individual who is a partner in a partnership that owns the disregarded entity. In such instances, the regulations provide that the entity is disregarded as an entity separate from its owner, and that the partners are subject to the same self-employment tax treatment as partners in a partnership that does not own a disregarded entity.
The preamble to the temporary regulations includes a request for comments as to whether Rev. Rul. 69-184 (which applies to to tiered partnership situations) ought to be modified to allow partnerships to treat partners as employees in certain circumstances—for example, employees in a partnership who obtain a small ownership interest in the partnership as an employee-compensatory award or incentive. Comments are requested concerning the implications of such changes on employee benefit plans and on employment taxes if Rev. Rul. 69-184 were to be modified to permit partners to be employees in certain instances.
The temporary 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 (based on the plans adopted before, and the plan years in effect as of May 4, 2016) sponsored by an entity that is a disregarded entity. This is intended to allow adequate time for partnerships to make payroll and benefit plan adjustments.
Read a May 2016 report [PDF 166 KB] prepared by KPMG LLP that addresses application of the Self Employment Contributions Act (SECA) to net income derived from self-employment—including by partners in partnerships and limited liability partnerships (LLPs), members in limited liability companies (LLCs), and sole proprietors. An entity may not realize that LLC or LLP members are subject to SECA.
Despite the language of the regulations, tax professionals believe that unfortunately the effective date provisions likely do not allow sufficient time for partnerships to adjust their systems to this change in guidance.
© 2020 KPMG LLP, a Delaware limited liability partnership and a member firm of the KPMG global organization of independent member firms affiliated with KPMG International Limited, a private English company limited by guarantee. All rights reserved.
For more detail about the structure of the KPMG global organization please visit https://home.kpmg/governance.
The KPMG logo and name are trademarks of KPMG International. KPMG International is a Swiss cooperative that serves as a coordinating entity for a network of independent member firms. KPMG International provides no audit or other client services. Such services are provided solely by member firms in their respective geographic areas. KPMG International and its member firms are legally distinct and separate entities. They are not and nothing contained herein shall be construed to place these entities in the relationship of parents, subsidiaries, agents, partners, or joint venturers. No member firm has any authority (actual, apparent, implied or otherwise) to obligate or bind KPMG International or any member firm in any manner whatsoever. The information contained in herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. For more information, contact KPMG's Federal Tax Legislative and Regulatory Services Group at: + 1 202 533 4366, 1801 K Street NW, Washington, DC 20006.