Partnerships are evil

[mphs77]

I have a client who is a partnership with a small wrinkle, one of the partners only takes W-2 income, no K-1. The other 4 partners do take K-1.

Is the one partner (who owns 30% of the partnership by the way), considered to be NOT Self Employed as he has no earned income to be reported?

Thanks for any guidance!

[masteff]

Considered to not be self-employed for purposes of what? You have to give us a context.

[mphs77]

Considered to not be self-employed for purposes of what? You have to give us a context.

For purposes of the definition of compensation.

The document specifies that W-2 income is used for Plan purposes, except for Self Employed Individuals, compensation means Earned Income.

Earned Income is defined as net earnings from self employment in the trade or business with respect to which the Employer has established the Plan, provided personal services of the self employed individual are a material income producing factor.

Thanks for all your help.

[masteff]

Okay, I'm w/ you now... so presumably he's a capital partner but does not participate in profits? In that case, my opinion is that he would not be self-employed w/ respect to the partnership. He would be an investor who is an employee of the partnership. But it would be good to have a copy of his K-1 in addition to the other partners, as it will reflect that he has a 0% share in profits.

[mphs77]

Okay, I'm w/ you now... so presumably he's a capital partner but does not participate in profits? In that case, my opinion is that he would not be self-employed w/ respect to the partnership. He would be an investor who is an employee of the partnership. But it would be good to have a copy of his K-1 in addition to the other partners, as it will reflect that he has a 0% share in profits.

Of course, he does not have a K-1, which I suppose would reinforce the idea that he is not self employed.

Thanks again!

[J Simmons]

Take a look at IRS' Field Service Advice 9999-9999-97, it lends support to Masteff's answer.

[mphs77]

Take a look at IRS' Field Service Advice 9999-9999-97, it lends support to Masteff's answer.

You sure on that FSA? Seems to be a lot of 9's.

Thanks

[J Simmons]

That's what the service I have specifies it. If you can't find it, send me your e-mail address and I'll send it to you.

[ERISAnut]

The issue with attempting to address the question is an inconsistency with the terminology being used. Your fact pattern suggests that the company is a partnership where it appears to operate as if it is an LLC taxed as a corporation. When considering K-1 when the entity is taxed as a partnership, only certain parts are considered 'earned income' to the owner while the remaining parts are considered passive income. However, if the entity is taxed as a corporation, then owner's benefit would be determined based on the W-2 compensation each owner takes; leaving all reported K-1 as passive income.

To suggest that they are taxed as a partnership while an owner receives W-2 lends itself to questions as to whether the fact pattern is correct. While it may be, try to ask the CPA preparing the K-1 to determine which amounts will be subject to FICA. This will certainly reveal your benefits eligible compensation of each owner.

[J Simmons]

When considering K-1 when the entity is taxed as a partnership, only certain parts are considered 'earned income' to the owner while the remaining parts are considered passive income.

ERISAnut, would you elaborate a bit more on this.

[mphs77]

The issue with attempting to address the question is an inconsistency with the terminology being used. Your fact pattern suggests that the company is a partnership where it appears to operate as if it is an LLC taxed as a corporation. When considering K-1 when the entity is taxed as a partnership, only certain parts are considered 'earned income' to the owner while the remaining parts are considered passive income. However, if the entity is taxed as a corporation, then owner's benefit would be determined based on the W-2 compensation each owner takes; leaving all reported K-1 as passive income.

To suggest that they are taxed as a partnership while an owner receives W-2 lends itself to questions as to whether the fact pattern is correct. While it may be, try to ask the CPA preparing the K-1 to determine which amounts will be subject to FICA. This will certainly reveal your benefits eligible compensation of each owner.

I do agree with the inconsistancy theme. I have checked with the accountant and the business entity is a Partnership. 4 of the partners receive K-1's to report their income, and 1 partner "chooses" to be paid a salary and no K-1 income. As this W-2 partner also makes salary deferrals, if earned income is the only basis in a partnership for defining compensation and he has none......Houston we have a problem.

Thanks for eveyone's input.

[K2retire]

I don't remember anything in the partnership tax laws that allows a partner to choose to receive a W-2 instead of a K-1. Kinda makes me wonder what other shady practices this client and his accountant are using.

[mphs77]

I don't remember anything in the partnership tax laws that allows a partner to choose to receive a W-2 instead of a K-1. Kinda makes me wonder what other shady practices this client and his accountant are using.

But the big question is.....do we really want to know?

[ERISAnut]

Here is the rule of thumb to apply to allieviate the concerns. The one consistent feature of 'earned income' is that it is subject to FICA. W-2 clearly satisfies this requirement, so it would be safe to say anyone can benefit on W-2.

But I do agree that the inconsistency of the owner within an entity that is not taxed as a corporation presents questions. I wouldn't let that affect the operation of the plan and treat the individual as a W-2 employee (who is still HCE and Key).

[masteff]

so presumably he's a capital partner but does not participate in profits

The inconsistency is easily explained if he's a capital-only partner (who should still get a K-1 but that's a separate issue). I can assure you as a CPA that this is not entirely uncommon. However... I agree that they've mischaracterized it and it's a source of potential confusion.