October 13, 2019

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New IRS Regulations Subject Certain Partners to Self-Employment Taxes

On May 3, 2016, the U.S. Department of the Treasury issued new temporary and proposed regulations (Temp. Treas. Reg § 301.7701-2T) addressing the tax treatment of partners of a partnership that is the sole owner of an entity that is not a corporation (a “disregarded entity”) that employs the partners.  The regulations provide that for employment tax purposes, these partners are not employees of the disregarded entity and instead are treated as self-employed individuals for federal employment tax and benefit plan purposes.

While a disregarded entity is ignored for federal income tax purposes, it is still treated as a corporation for federal employment tax purposes.  However, a disregarded entity is not treated as a corporation for self-employment tax purposes. Accordingly, an individual owner is responsible for self-employment taxes on the net earnings of a disregarded entity owned by the individual.  See Treas. Reg § 301.7701-2(c)(2).

The recently issued temporary regulations provide that the rule that a wholly owned disregarded entity is disregarded for self-employment tax purposes also applies to partners in a partnership owning a disregarded entity. Characterizing such partners as self-employed individuals with respect to the disregarded entity subjects them to self-employment taxes. Additionally, self-employed partners are unable to participate in certain tax-favored benefit plans offered by the disregarded entity, such as “cafeteria” or Section 125 flexible spending and dependent care programs and are ineligible to exclude employer-provided accident and health plans from gross income.

The effective date of the temporary regulations is the later of August 1, 2016, or the first day of the latest starting plan year following May 4, 2016, of an affected health or retirement plan sponsored by a disregarded entity.

© 2019 Proskauer Rose LLP.


About this Author

Gabriela Ahdoot, Proskauer Law Firm, Employee Benefits and Tax Law Clerk
Law Clerk

Gabriella Ahdoot is a law clerk in the Tax Department and a member of the Employee Benefits, Executive Compensation & ERISA Litigation Group.

In the executive compensation area, Gabriella represents senior executives, corporations and compensation committees in a wide range of executive compensation matters, including drafting securities filings, equity plans, and award and severance agreements.

In the employee benefits area, Gabriella represents multi-employer benefit plan...