Partners in a partnership are generally considered self-employed rather than employees. This classification has significant implications for tax purposes, particularly concerning the application of self-employment taxes and the treatment of income received from the partnership.
- Self-Employment Status: According to the IRS guidelines and various legal interpretations, bona fide members of a partnership are not considered employees for purposes of the Federal Insurance Contributions Act (FICA), the Federal Unemployment Tax Act (FUTA), and the Collection of Income Tax at Source on Wages. Instead, they are classified as self-employed individuals. This means that any remuneration received by a partner from the partnership is not treated as wages and is not subject to federal income tax withholding. Instead, it is subject to self-employment tax under the Self Employment Contributions Act (SECA).
- Income Treatment: Partners must include their distributive share of the partnership's income or loss on their individual tax returns. This income is considered self-employment income and is subject to self-employment tax. This includes guaranteed payments received for services rendered to the partnership, which are also treated as self-employment income.
- Legal Precedents and IRS Rulings: The IRS has consistently held that partners are not employees for tax purposes. For instance, in Rev. Rul. 69-184, it was clarified that bona fide members of a partnership are self-employed and not employees. This ruling has been upheld in various legal cases and IRS advisories, reinforcing the position that partners should be treated as self-employed individuals.
- Limited Partners: There is a distinction between general partners and limited partners. General partners are subject to self-employment tax on their distributive share of partnership income and guaranteed payments. Limited partners, however, are generally not subject to self-employment tax on their distributive share of partnership income, but they do pay self-employment tax on guaranteed payments for services rendered to the partnership.
- Functional Test: The IRS and courts apply a functional test to determine whether a partner is truly a limited partner for self-employment tax purposes. This test considers factors such as personal liability for partnership debts, authority to contract on behalf of the partnership, and participation in the partnership's business activities.
In summary, partners in a partnership are considered self-employed for federal tax purposes, not employees. This classification affects how their income is taxed and their obligations under self-employment tax laws.
Sources:
When Is a Limited Partner Not a Limited Partner?
Publication 15-A (2024)
CCA 201436049
Rev. Rul. 69-184
Publication 541 (3/2021)
CCA 200117003
