United States

Potential tax traps for employees who become partners


Recently proposed regulations have renewed discussions regarding the IRS position that a partner in a partnership cannot also be an employee of that partnership.

While some question the validity of that view, if it is deemed to be correct, a partner receiving fixed payments as compensation for services must treat them as guaranteed payments reported on Schedule K-1 and not as a salary reported on Form W-2.

If an existing employee’s wages are converted into partner guaranteed payments, more will change than the tax forms. A partner receiving such a payment may seek an increase in gross compensation to make up for the fact that they will now be responsible for a greater share of their Social Security taxes under the self-employment tax rules.

In addition, there will be changes to the tax treatment of certain fringe benefits. For example, a partner who is eligible to participate in a spouse’s health care plan, but chooses not to, will likely not qualify for a deduction for self-employed health insurance premium deductions and will also not enjoy the ability to receive tax-free health insurance from the partnership.

Before making any changes, employers should consider discussing the tax and other consequences with their workers.

Jennifer Kalla


Jennifer provides proactive business and personal tax planning, including changes in ownership and business expansion. Reach her at jennifer.kalla@rsmus.com.

Areas of focus: Federal TaxIndustrialsConsumer Products

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