Self-employment Tax Treatment of Partners in a Partnership that Owns a Disregarded Entity

IRS recently issued T.D. 9766, temporary regulations effective the later of August 1, 2016 or the first day of the latest starting plan year following May 4, 2016, to clarify the treatment of partners in a partnership that owns a disregarded entity. The regulation was issued to clarify that those partners are not treated as employees. Regulations previously issued, § 301-7701-2( c )(2)(iv)(d) may have been misunderstood and some taxpayers have permitted partners to participate in certain tax-favored employee benefit plans.

The regulation §301.7701-2(c)(2)(i) applies self-employment tax rules to any owner of a disregarded entity without carving out an exception regarding a partnership that owns such a disregarded entity. Rev. Rul. 69 - 184, 1969 - 1 CB 256, provides that  bona fide members of a partnership are not employees of the partnership, within the meaning of the Federal Insurance Contributions Act, the Federal Unemployment Tax Act, and the Collection of Income Tax at Source on Wages.  In addition, the partner who devotes time and energy in the conduct of the trade or business of the partnership, or in providing services to the partnership as an independent contractor, is, in either event, a self-employed individual.

If a partnership is the owner of the disregarded entity, the partners in the partnership are subject to the same self-employment tax rules as partners in a partnership that does not own a disregarded entity. 

The regulations specifically do not address Rev. Rul. 69-184, which applies to tiered-partnership situations where a partner may also be an employee of the partnership and be eligible for certain employee benefit plans. The full regulation can be found at:  https://s3.amazonaws.com/public-inspection.federalregister.gov/2016-10383.pdf