Can Partners be W2 employee's?

[Harvey Lucas]

For 2006 my client is a 4 member LLC. We filed a 2006 1065, all profit was reflected on k1 forms, each partner paid SE tax based on his share of profits.

Partner #4, his wife was the bookeeper, told me that beginning 1-1-07 they were going to be taxed as a S-corp. Told me that the 2553 was signed by all the members and sent to IRS.

Yesterday, client called, seems Partner #4 walked out and there is now a big dispute about how he is to be cashed out, bought out or ?

I asked the bookeeper to verify for me that the 2553 had been filed, ie, give me a copy of the IRS letter saying that they are an S-corp for 2007.

And...you guessed it, IRS has no record of S election, they are still a 1065 for 2007.

Now comes the problem....thinking they were an S-Corp for 2007, they began paying
W2 payroll for all the members beginning January 1. They witheld taxes, filed 941's etc, etc.

We all know that "partners" (LLC members taxed as partners) can't be W2 employee's, however, Q1, Q2 and Q3 941's have already been filed as if they were.

It seems like the logical thing to do is simply finish out the year the same way, issue them W2 forms, treat any extra profit as K1 taxable to each member.

Then decide what to do about 2008.

Does anyone see any problems with this approach?

Thank You,
Harvey Lucas

[RLymanC]

941's

One approach would be to file corrected 941's and get a refund of all taxes paid.

[Kram BergGold]

I see a problem

Partner's can't get W-2 forms, this is the problem. You have to correct the 941's.

[Bees Knees]

The logical thing to do is to file a late S election under one of the numerous procedures available. They intended to be an S corporation. They acted like an S corporation when they filed the 941s.

Its far less complicated and far less expensive for you to do that than to try and null and void a years worth of 941s, withholding, and the like. If the one partner squawks and doesn’t cooperate with you getting the late 2553 through, tell him there won't be anything left to liquidate after your fee for having to re-do everything.

[Harvey Lucas]

I'm wondering if there is any real problem to simply finish the year using the W2 reporting method?

I agree, it is not the correct way to do it, however, if there were an audit it seems it would be unlikely that there would be a change in the overall correct amount of tax.

It seems over the years that I have seen a few partnerships report in this fashion and have never heard of any ill coming from it. Has anyone else?

Now that we have discovered that they are not an S-Corp, I am not sure that Partners #1, #2, and #3 want to be an S-Corp, it was Partner #4's idea in the first place, the others simply went along with the idea..

Partner #4's departure has caused quite a stink and there will be litigation because of it that has already begun.

The client does their own accounting and payroll inhouse using Quickbooks. They file their own 941's etc. They provide me a P&L, Bal Sheet, and other documents at year end so I can prepare the Income Tax Return.

The situation is already messy....I don't want to make it worse by advising them to change the payroll reporting method when the year is almost over.

Again, has anyone ever heard of a partnership (or LLC taxed as a partnership) reporting its partners as W2 employees and sufferred any negative consequences because if it?

Thank You,
Harvey Lucas

[JoshinNC]

I have about 20 MMLLC's

I'm wondering if there is any real problem to simply finish the year using the W2 reporting method?

I agree, it is not the correct way to do it, however, if there were an audit it seems it would be unlikely that there would be a change in the overall correct amount of tax.

It seems over the years that I have seen a few partnerships report in this fashion and have never heard of any ill coming from it. Has anyone else?

Now that we have discovered that they are not an S-Corp, I am not sure that Partners #1, #2, and #3 want to be an S-Corp, it was Partner #4's idea in the first place, the others simply went along with the idea..

Partner #4's departure has caused quite a stink and there will be litigation because of it that has already begun.

The client does their own accounting and payroll inhouse using Quickbooks. They file their own 941's etc. They provide me a P&L, Bal Sheet, and other documents at year end so I can prepare the Income Tax Return.

The situation is already messy....I don't want to make it worse by advising them to change the payroll reporting method when the year is almost over.

Again, has anyone ever heard of a partnership (or LLC taxed as a partnership) reporting its partners as W2 employees and sufferred any negative consequences because if it?

Thank You,
Harvey Lucas

and maybe 25% do payroll for one or more partners and issue W-2's to them. Never had the IRS come back and say something. My opinion is that some of these folks would spend the money if it was in their pocket, so doing the withholdings is the only way to ensure that taxes get sent in. Yes, they have to pay UI and FUTA when they shouldn't, but they understand that. As Dave Ramsey would say, they've got to pay some "stupid tax".

[Golden Rocket]

I'm Guilty

Several years ago I helped one of my partnerships issue W-2s, as they had partner's on weekly salaries, and at the time I was unaware of what constituted guaranteed payments.
I now know better.

No one suffered any repercussions from this, but the partners and I were violating Rev. Ruling 69-184.

[Bees Knees]

The situation is already messy....I don't want to make it worse by advising them to change the payroll reporting method when the year is almost over.

Again, has anyone ever heard of a partnership (or LLC taxed as a partnership) reporting its partners as W2 employees and sufferred any negative consequences because if it?

Your concern should be with your own practice. Do you want IRS hitting you with the new $5,000 penalty for taking a reckless or intentional disregard of rules or regulations position under Section 6694(b)?

It is irrelevant how often IRS catches people breaking the rules. Your practice is not worth taking the lazy way out. Fix it, and charge your client accordingly. Its not your fault things got messed up. That is your job. Fixing messes.

[Bees Knees]

and maybe 25% do payroll for one or more partners and issue W-2's to them. Never had the IRS come back and say something. My opinion is that some of these folks would spend the money if it was in their pocket, so doing the withholdings is the only way to ensure that taxes get sent in. Yes, they have to pay UI and FUTA when they shouldn't, but they understand that. As Dave Ramsey would say, they've got to pay some "stupid tax".

IRS stupidity is no reason to continue breaking the rules. A partner is subject to SE tax on Guaranteed payments. Did you pay SE tax?

And if you answered yes you did because the partnership paid FICA, your answer would be incorrect. Under the law, paying FICA tax is not a deduction against SE tax. IRS can assess you SE tax on self-employment income even if you paid FICA tax on the same amount.

[Bees Knees]

OK OK, before somebody accuses me of blowing this way out of proportion, actually, there is no evidence that IRS will do anything even though they say it is wrong. Obviously, they collect just as much if not more tax when you treat a partner as an employee verses being self employed. In fact, since LLC members may be exempt from SE tax on K1 line 1 profits, they may collect even more tax treating partners as employees verses as a partner.

I doubt any preparer will get in trouble for this, in fact, some courts have allowed employee treatment according to this article I found on the Illinois CPA Society"s Web Page:

Are Partners treating themselves as Employees?

September 25, 2007

Steven R. Goluch, CPA, MST
Wolowicki and Associates, LLC
steve@wolowicki.com

Key Highlight: How should you handle Partner Compensation Issues?

The IRS has long held with its Rev. Rul. 69-184 that a Partner should not be treated as an employee for purposes of compensation. In its ruling the IRS does not provide any discussion, authority or analysis in its decision. There has been very little case law in this area as some courts have allowed a partner to be treated as an employee in very limited circumstances, see Armstrong v. Phinney, CA-5 (68-1 USTC ¶9355, 394 F2d 661)

Today, in practice it is not uncommon to find when we take on a new LLC or Partnership client that the partners/members are being treated as employees.

Most often our clients argue that it is more convenient to be treated as employees for purposes of having withholding versus making estimated tax payments, and for ease of making regular distributions with their payroll service.

However, this treatment can pose additional problems if the partners are including themselves in the medical plans and other employer fringe benefit plans.

The issue has taken on a new significance with the Manufacturer's Deduction under Section 199. Since the deduction is limited to 50% of the wages paid by the entity and partner guaranteed payments are not considered compensation for purposes of the limitation.

While the IRS position is clear, the Courts have been more willing to take a broader stance on the issue of the partner vs. employee. Due to the lack of significant guidance and authority this issue remains wrapped in uncertainty.

The Flow Through Entity committee of the Society is interested in how you and/or your firm addresses the issue of partner compensation. This issue is a recurring topic for many of Society's members and the Committee will be publishing a series of articles in upcoming Practice Advantage discussing the advantages and disadvantages of treating partners as employees.

[TAX]

Just refile 2553

Just keep it simple.

(1) File 2553 and in a letter mention about late election for LLC to be taxed as s corp effective 01/01/07

(2) Look at Taxbook Rev. procedure (2003-43)

(3) Fax two documents to IRS: 2553 & Letter

(4) Charge client $

You are done! (Chances of rejections are vey very very less)!

I just did and got approved. Send me private e-mail if you need help.

[dsi]

The result is we all want to see our clients get refunds, or at the very least pay little in taxes. The problem is, do we put band-aids over the wounds or do we correct them. This is something that's up to our individual conscious.

[Joe Btfsplk]

W-2 to partners

Partner's can't get W-2 forms, this is the problem. You have to correct the 941's.

Partners CAN get W-2s. Despite the rules which specify guaranteed payments, the effect of a W-2 is the same as paying SE tax based on guaranteed payments. The IRS does not quibble about this type of thing.

I even had a client issue a W-2 for his sole proprietorship. He was audited by the IRS and the auditor was well aware of his W-2 but did not question it since the tax paid was not understated.

[Harvey Lucas]

Thank You All

Thank you all for your thoughtfull insight.

It is very dificult to find guidance for these types of issues because issues that are "outside the box" are usually not written about in reference books.

That is why I find this board is so valuable.

Thanks Again,
Harvey Lucas

[Pam Kemp]

Partners & W2s

Partner's can't get W-2 forms, this is the problem. You have to correct the 941's.

Partners & members are not allowed to receive W2 wages - but if the entity has elected to be taxed as a corporation, can W2 wages then be paid ? If not, how should the guaranteed payments be declared on the 1120 S ?