Partner-Employee Dual Status Push May Gain Momentum

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By Laura Davison

Feb. 8 — The IRS is being asked to reconsider its ban on partners also serving as employees of a company as the practice becomes more common, despite the prohibition.

“The government has a problem in that dual status is de facto at this point,” Leigh Griffith, a partner at Waller Lansden Dortch & Davis LLP, told Bloomberg BNA Feb. 8. “Anecdotally, it is becoming much more common every year. LLC interests are being given out to middle management and sometimes below.”

The government historically hasn't allowed for individuals to receive both a W-2 and a Schedule K-1 from a partner because of the complexity of differentiating the income streams and to avoid situations where individuals could take advantage of the benefits an employee receives and the favorable tax treatment of profits interests.

Small Service Partnerships

Griffith, along with other American Bar Association tax section members, are pushing the Internal Revenue Service to soften its stance in light of the widespread practice of what he calls “rank-and-file” partners in small service partnerships. The goal is to allow partnerships and limited liability companies to elect to treat partners, who own small interests, as employees for benefit purposes and to treat their guaranteed payments as W-2 wages.

Owners, typically of LLCs, hand out equity in the business to incentivize employees to improve the company's productivity or reward longtime employees as an alternative to cutting them a check, Griffith said.

However, these employees and employers—not realizing this has caused the partnership interest recipient to enter the realm of the self-employed—continue to treat the employee's earnings as wages, rather than “grossing up” the employee's pay, and having them file quarterly estimated tax payments and pay Self-Employment Contributions Act (SECA) taxes.

Partnership Parity

“We hope at least to clarify the rules that apply to rank-and-and-file employees,” Kurt Lawson, a partner at Hogan Lovells US LLP in Washington, said Feb. 8. “Under Revenue Ruling 69-184 they potentially become subject to a more complicated tax payment regime—including the need to pay estimated taxes, lose access to some standard employee benefits like cafeteria plans, and lose protections under some laws including the Affordable Car Act, as soon as they receive partnership interests, unlike similarly situated employees of corporations.”

IRS officials have said they are encouraging comments on the issue, though a formal request for comment hasn't been released.

Griffith, who is based in Nashville, Tenn., said he and a committee are working on comments that outline situations it hopes the government would consider for dual-status treatment. Their focus is on the size of the partnership stake, the industry and the position the employee-partner holds.

The ABA Section of Taxation suggested in 2011 that individuals with no more than a 10 percent stake should be able to continue to qualify as employees if they are providing additional services to the partnership. Ten percent might be on the high side of what the government could ultimately consider allowing, Griffith said ,

Designated Government Guy

This is an area that the government could move slowly, based on the difficulty of reaching an mutually agreeable answer under tax code Section 707 and because rules could also apply to investment partnerships where government officials are more wary of potential abuse. Partnership interests aren't something to be given “out like candy,” Glenn Dance, IRS special counsel to the associate chief counsel (Passthroughs and Special Industries), said at an ABA tax section meeting.

“I don’t want to be unsympathetic, but I’m the designated hard-ass as the government guy,” Dance said Jan. 29. “There were things about making partner that were not so cool.”

“What did we all think to ourselves when we made partner at our firms?” he said. “It’s worth it. The firm is making it worth it for all this inconvenience.”

To contact the reporter on this story: Laura Davison in Washington at

To contact the editor responsible for this story: Brett Ferguson at