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Self-Employment Tax for Partners of Partnership Owning Disregarded Entity

Treasury Regulation (“Reg.”) Section 301.7701-2(c)(2)(iv)(B) generally provides that a disregarded entity is treated as a corporation for employment tax purposes. However, this rule does not apply for self-employment (SE) tax purposes. Therefore, the owner of a disregarded entity treated as a sole proprietorship is subject to tax on SE income. The IRS has issued final regulations clarifying this rule by providing that partners of a partnership that owns a disregarded entity are not employees of the disregarded entity and are therefore subject to SE tax. The final regulations, which adopt without substantive changes temporary and proposed regulations issued in 2017, apply on the later of (1) August 1, 2016 or (2) the first day of the latest-starting plan year beginning after May 4, 2016, and on or before May 4, 2017, of an affected plan – certain qualified, health, and Section 125 cafeteria plans – (based on the plans adopted before, and the plan years in effect as of, May 4, 2016) sponsored by a disregarded entity.

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