"Of counsel"--are they employees?

[Laura Harrington]

We have a client with a 401(k) plan that is a law firm. They have several individuals they call "of counsel" employees who were former partners of the law firm.

Most years these "of counsel" employees receive a K-1 reflecting self-employment income on line 14, code A when they receive payment for prior services or when they perform current services for the law firm.

The client says that their former TPA told them they didn't have to report these individuals, because they are not employees. But I question this.

I know that "of counsel" relationships can be structured to be an employment relationship or an independent contractor relationship. But my thought is that since they are reporting the income on the K-1 (all as guaranteed payment), and the payment is for personal services rendered to the employer, that the individuals are indeed self-employed individuals, which makes them employees of the law firm.

If it was an independent contractor relationship they should issue them a 1099 instead of a K-1, right?

Any thoughts? Am I missing anything?

[Bird]

Like you, I would prefer to think that if they are not being paid on a 1099 then they are not independent contractors for reporting purposes. (Of course, reporting errors are usually the other way around, true employees being reporting as independent contractors.)

But, I think it is possible that they really aren't functioning as employees, and the comp should be ignored. I'm pretty sure that it makes no difference on the tax side since partners pay their own SE taxes just like an IC.

So, I think I'd accept their determination that these people are not employees if that's what they told me. I'd caveat it by telling them that it's likely to raise questions on audit and it would be a lot simpler if they just reported them as ICs. Just guessing, but I'm thinking that the accountant had these people in their system as partners and figures it doesn't really matter and can't be bothered to change it.

[jpod]

I would mention to the client that they can't be k-1 partners for certain tax purposes and ICs for qualfied plan purposes. It would be good if you can get something in writing from the client confirming that it was mistake to report their comp. on a k-1 and that they are truly ICs.