[Federal Register Volume 81, Number 86 (Wednesday, May 4, 2016)]
[Rules and Regulations]
[Pages 26693-26695]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2016-10383]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 301

[TD 9766]
RIN 1545-BM87


Self-Employment Tax Treatment of Partners in a Partnership That 
Owns a Disregarded Entity

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final and temporary regulations.

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SUMMARY: This document contains final and temporary regulations that 
clarify the employment tax treatment of partners in a partnership that 
owns a disregarded entity. These regulations affect partners in a 
partnership that owns a disregarded entity. The text of these temporary 
regulations serves as the text of proposed regulations (REG-114307-15) 
published in the Proposed Rules section in this issue of the Federal 
Register.

DATES: Effective date: These regulations are effective on May 4, 2016.
    Applicability date: For date of applicability, see Sec.  301-7701-
2T(e)(8).

FOR FURTHER INFORMATION CONTACT: Andrew K. Holubeck at (202) 317-4774 
(not a toll-free number).

SUPPLEMENTARY INFORMATION: 

Background

    Section 301.7701-2(c)(2)(i) states that, except as otherwise 
provided, a business entity that has a single owner and is not a 
corporation under Sec.  301.7701-2(b) is disregarded as an entity 
separate from its owner (a disregarded entity). However, Sec.  
301.7701-2(c)(2)(iv)(B) provides that an entity that is a disregarded 
entity is treated as a corporation for purposes of employment taxes 
imposed under subtitle C of the Internal Revenue Code (Code). 
Therefore, the disregarded entity, rather than the owner, is considered 
to be the employer of the entity's employees for purposes of employment 
taxes imposed by subtitle C.
    While Sec.  301.7701-2(c)(2)(iv)(B) treats a disregarded entity as 
a corporation for employment tax purposes, this rule does not apply for 
self-employment tax purposes. Specifically, Sec.  301.7701-
2(c)(2)(iv)(C)(2) provides that the general rule of Sec.  301.7701-
2(c)(2)(i) applies for self-employment tax purposes. After setting 
forth this general rule, the regulation applies this rule in the 
context of a single individual owner by stating that the owner of an 
entity that is treated in the same manner as a sole proprietorship is 
subject to tax on self-employment income. The regulation, at Sec.  
301.7701-2(c)(2)(iv)(D), also includes an example that specifically 
illustrates the mechanics of the rule. In the example, the disregarded 
entity is subject to employment tax with respect to employees of the 
disregarded entity. The individual owner, however, is subject to self-
employment tax on the net earnings from self-employment resulting from 
the disregarded entity's activities. The regulations do not include a 
separate example in which the disregarded entity is owned by a 
partnership.
    It has come to the attention of the Treasury Department and the IRS 
that even though the regulations set forth a general rule that an 
entity is disregarded as a separate entity from the owner for self-
employment tax purposes, some taxpayers may have read the current 
regulations to permit the treatment of individual partners in a 
partnership that owns a disregarded entity as employees of the 
disregarded entity because the regulations did not include a specific 
example applying the general rule in the partnership context. Under 
this reading, which was not intended, some taxpayers have permitted 
partners to participate in certain tax-favored employee benefit plans. 
The Treasury Department and the IRS note that the regulations did not 
create a distinction between a disregarded entity owned by an 
individual (that is, a sole proprietorship) and a disregarded entity 
owned by a partnership in the application of the self-employment tax 
rule. Rather, Sec.  301.7701-2(c)(2)(iv)(C)(2) provides that the 
general rule of Sec.  301.7701-2(c)(2)(i) applies for self-employment 
tax purposes for any owner of a disregarded entity without carving out 
an exception regarding a partnership that owns such a disregarded 
entity. In addition, the Treasury Department and the IRS do not believe 
that the regulations alter the holding of Rev. Rul. 69-184, 1969-1 CB 
256, which provides that: (1) 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 (chapters 21, 23, and 24, 
respectively, subtitle C, Internal Revenue Code of 1954), and (2) such 
a 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 rather than an individual who, under the usual 
common law rules applicable in determining the employer-employee 
relationship, has the status of an employee.
    To address this issue, the Treasury Department and the IRS clarify 
in these temporary regulations that the rule that a disregarded entity 
is treated as a corporation for employment tax purposes does not apply 
to the self-employment tax treatment of any individuals who are 
partners in a partnership that owns a disregarded entity. The rule that 
the entity is disregarded for self-employment tax purposes applies to 
partners in the same way that it applies to a sole proprietor owner. 
Accordingly, the partners are subject to the same self-employment tax 
rules as partners in a partnership that does not own a disregarded 
entity.

Explanation of Provisions

    This document contains amendments to the Procedure and 
Administration Regulations (26 CFR part 301) under section 7701 of the 
Code to clarify that a disregarded entity that is treated as a 
corporation for purposes of employment taxes imposed under subtitle C 
of the

[[Page 26694]]

Code is not treated as a corporation for purposes of employing its 
individual owner, who is treated as a sole proprietor, or employing an 
individual that is a partner in a partnership that owns the disregarded 
entity. Rather, the entity is disregarded as an entity separate from 
its owner for this purpose. Existing regulations already provide that 
the entity is disregarded for self-employment tax purposes and 
specifically note that the owner of an entity treated in the same 
manner as a sole proprietorship under Sec.  301.7701-2(a) is subject to 
tax on self-employment income. These temporary regulations apply this 
existing general rule to illustrate that, if a partnership is the owner 
of a 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.
    While these temporary regulations provide that a disregarded entity 
owned by a partnership is not treated as a corporation for purposes of 
employing any partner of the partnership, these regulations do not 
address the application of Rev. Rul. 69-184 in tiered partnership 
situations. Several commenters have requested that the IRS provide 
additional guidance on the application of Rev. Rul. 69-184 to tiered 
partnership situations, and have also suggested modifying the holding 
of Rev. Rul. 69-184 to allow partnerships to treat partners as 
employees in certain circumstances, such as, for example, employees in 
a partnership who obtain a small ownership interest in the partnership 
as an employee compensatory award or incentive. However, these 
commenters have not provided detailed analyses and suggestions as to 
how the employee benefit and employment tax rules would apply in such 
situations. The Treasury Department and the IRS request comments on the 
appropriate application of the principles of Rev. Rul. 69-184 to tiered 
partnership situations, the circumstances in which it may be 
appropriate to permit partners to also be employees of the partnership, 
and the impact on employee benefit plans (including, but not limited 
to, qualified retirement plans, health and welfare plans, and fringe 
benefit plans) and on employment taxes if Rev. Rul. 69-184 were to be 
modified to permit partners to also be employees in certain 
circumstances.
    In order to allow adequate time for partnerships to make necessary 
payroll and benefit plan adjustments, these temporary regulations will 
apply 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 disregarded as an entity 
separate from its owner for any purpose under Sec.  301.7701-2. For 
these purposes, an affected plan includes any qualified plan, health 
plan, or section 125 cafeteria plan if the plan benefits participants 
whose employment status is affected by these regulations. For rules 
that apply before the applicability date of these regulations, see 26 
CFR part 301 revised as of April 1, 2016.

Special Analysis

    Certain IRS regulations, including this one, are exempt from the 
requirements of Executive Order 12866, as supplemented and reaffirmed 
by Executive Order 13563. Therefore, a regulatory impact assessment is 
not required. It has also been determined that section 553(b) of the 
Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to 
these regulations. For applicability of the Regulatory Flexibility Act 
(5 U.S.C. chapter 6), please refer to the Special Analysis section in 
the preamble to the cross-referenced notice of proposed rulemaking in 
the Proposed Rules section of this issue of the Federal Register. 
Pursuant to section 7805(f) of the Code, these regulations were 
submitted to the Chief Counsel for Advocacy of the Small Business 
Administration for comment on its impact on small business.

Drafting Information

    The principal author of these regulations is Andrew Holubeck of the 
Office of the Division Counsel/Associate Chief Counsel (Tax Exempt and 
Government Entities). However, other personnel from the IRS and the 
Treasury Department participated in their development.

List of Subjects in 26 CFR Part 301

    Employment taxes, Estate taxes, Excise taxes, Gift taxes, Income 
taxes, Penalties, Reporting and recordkeeping requirements.

Amendments to the Regulations

    Accordingly, 26 CFR part 301 is amended as follows:

PART 301--PROCEDURE AND ADMINISTRATION

0
Paragraph 1. The authority citation for part 301 continues to read in 
part as follows:

    Authority:  26 U.S.C. 7805 * * *


0
Par. 2. Section 301.7701-2 is amended by:
0
1. Revising paragraph (c)(2)(iv)(C)(2).
0
2. Adding paragraph (e)(8).
    The revision and addition reads as follows:


Sec.  301.7701-2  Business entities; definitions.

* * * * *
    (c) * * *
    (2) * * *
    (iv) * * *
    (C) * * *
    (2) [Reserved]. For further guidance, see Sec.  301.7701-
2T(c)(2)(iv)(C)(2).
* * * * *
    (e)(8) [Reserved]. For further guidance, see Sec.  301.7701-
2T(e)(8).


0
Par. 3. Section 301.7701-2T is added to read as follows:


Sec.  301.7701-2T  Business entities; definitions (temporary).

    (a) through (c)(2)(iv)(C)(1) [Reserved]. For further guidance, see 
Sec.  301.7701-2(a) through (c)(2)(iv)(C)(1).
    (2) Section 301.7701-2(c)(2)(i) applies to taxes imposed under 
subtitle A, including Chapter 2--Tax on Self-Employment Income. Thus, 
an entity that is treated in the same manner as a sole proprietorship 
under Sec.  301.7701-2(a) is not treated as a corporation for purposes 
of employing its owner; instead, the entity is disregarded as an entity 
separate from its owner for this purpose and is not the employer of its 
owner. The owner will be subject to self-employment tax on self-
employment income with respect to the entity's activities. Also, if a 
partnership is the owner of an entity that is disregarded as an entity 
separate from its owner for any purpose under Sec.  301.7701-2, the 
entity is not treated as a corporation for purposes of employing a 
partner of the partnership that owns the entity; instead, the entity is 
disregarded as an entity separate from the partnership for this purpose 
and is not the employer of any partner of the partnership that owns the 
entity. A partner of a partnership that owns an entity that is 
disregarded as an entity separate from its owner for any purpose under 
Sec.  301.7701-2 is subject to the same self-employment tax rules as a 
partner of a partnership that does not own an entity that is 
disregarded as an entity separate from its owner for any purpose under 
Sec.  301.7701-2.
    (c)(2)(iv)(D) through (e)(7) [Reserved]. For further guidance, see 
Sec.  301.7701-2(c)(2)(iv)(D) through (e)(7).
    (8)(i) Effective/applicability date. Paragraph (c)(2)(iv)(C)(2) of 
this section applies on the later of--
    (A) August 1, 2016, or

[[Page 26695]]

    (B) 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 
disregarded as an entity separate from its owner for any purpose under 
Sec.  301.7701-2. For rules that apply before the applicability date of 
these regulations, see 26 CFR part 301 revised as of April 1, 2016. For 
these purposes--
    (1) An affected plan includes any qualified plan, health plan, or 
section 125 cafeteria plan if the plan benefits participants whose 
employment status is affected by paragraph (c)(2)(iv)(C)(2),
    (2) A qualified plan means a plan, contract, pension, or trust 
described in paragraph (A) or (B) of section 219(g)(5) (other than 
paragraph (A)(iii)), and
    (3) A health plan means an arrangement described under Sec.  1.105-
5 of this chapter.
    (ii) Expiration date. The applicability of paragraph 
(c)(2)(iv)(C)(2) of this section expires on or before May 3, 2016, or 
such earlier date as may be determined under amendments to the 
regulations issued after May 3, 2016.

John M. Dalrymple,
Deputy Commissioner for Services and Enforcement.
    Approved: April 20, 2016.
Mark J. Mazur,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2016-10383 Filed 5-3-16; 8:45 am]
 BILLING CODE 4830-01-P