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Associate Attorney - Tax (Honolulu HI)
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|Question 155: What effect does IRS Notice 99-6 have on your response in Q&A 154? It says that a disregarded entity can pay employment taxes as though it weren't disregarded. That seems to contradict your conclusions about partners not being employees of single member LLCs that are wholly owned by the partnership.|
Answer: Properly understood, I don't think it does, and one of the authors of that Notice agrees. Relax, grab a glass of your favorite beverage, and let me tell you a story about the interaction that sometimes happens with this column, and then I'll explain how I came to that conclusion.
As I noted in Q&A 154, an LLC that has a single member is disregarded for tax purposes unless it is taxed as a corporation. Apparently, some taxpayers felt that this "disregarding" was limited to income tax returns. Notice 99-6 labels that view as "incorrect," and points out that the LLC is disregarded for all tax purposes, including employment tax issues. It also said commentators had pointed out that this posed practical difficulties, and they would rather file and pay employment taxes at the level of the disregarded LLC.
Given this situation, the IRS has requested comments and has said that the following rules apply while they sort things out:
In effect, the IRS has said "It doesn't really matter to us whether the correct method is followed, and the LLC's owner files and pays the employment taxes, or whether you choose instead to let an entity we are generally ignoring file the returns and pay the taxes. We just want to make sure that a return is filed and the tax is paid." This is a sensible position, to allow the taxpayer to decide what is easiest for them. The dollars end up being the same either way.
Except, as regards the issue in Q&A 154. Someone might be treated as an employee of the disregarded LLC, but not be an employee of the partnership. Let me illustrate the quandry with an couple of examples:
The question concerns what we do with Jack if AB chooses to have XYZ file and pay employment taxes on its employees. Does it include Jack as one of those employees or not? I answer "no," because the whole thrust of Notice 99-6 is "it doesn't matter whether AB pays the tax out of its general pocket, or out of its XYZ pocket, so long as the tax is paid." That's the effect of the IRS statement that "This method merely permits the employment tax obligations of the owner incurred with respect to the disregarded entity to be fulfilled through the separate calculation, reporting, and payment of employment taxes by the disregarded entity." (See also Rev. Rul 2001-51.)
Notice 99-6 does not change the fundamentals of the tax amount or determination. It just changes how many returns are filed and payments are transferred. To treat Jack as an employee in this situation, when he clearly would not be an employee if AB paid the payroll taxes directly, would be to change fundamentally not only who pays the taxes, but also how much is to be paid.
It would also add great confusion to the retirement plan arena. Why? Because Notice 99-6, by its terms is limited to "reporting and payment of employment taxes." It does not purport to affect, in any way, the determination of employee status for retirement plan purposes.
This means that, regardless of how AB chooses to file its payroll taxes, Jack is a self-employed individual with respect to AB, and not a common law employee. That's the conclusion of Q&A 154 and Notice 99-6 does nothing to change that conclusion.
Thus, even if AB or XYZ mistakenly gives Jack a W-2, he is still a self-employed individual and his compensation for plan purposes is computed accordingly. I know of no guidance in this area, but I suggest that Jack's compensation is based on what his net earnings from self-employment would have been had AB filed its return properly and reflected payments to Jack as guaranteed payments on his K-1. That would be his gross pay, increased by the employer's share of payroll taxes paid with respect to Jack. From this, we would deduct 1/2 of what Jack should be paying as self-employment tax, plus retirement contributions made on his behalf, to arrive at his earned income. That is the amount treated as his compensation.
Other issues involving self-employed individuals are discussed in Chapter 1 of my book, Who's the Employer.
If Mr. Richards or my other readers have comments, I'd be delighted to hear them. You can reach me through the Ask a Question link, below.
Answers are provided as general guidance on the subjects covered in the question and are not provided as legal advice to the questioner or to readers. Any legal issues should be reviewed by your legal counsel to apply the law to the particular facts of this and similar situations.
The law in this area changes frequently. Answers are believed to be correct as of the posting dates shown. The completeness or accuracy of a particular answer may be affected by changes in the law (statutes, regulations, rulings, court decisions, etc.) that occur after the date on which a particular Q&A is posted.