Partnership, but one "partner" gets a W-2

[CuriousCaliColo]

Situation:
Colorado resident has a website business with one other person, a California resident.
California partner and Colorado partner split the profit 50/50.
The California partner does all the bookkeeping.
The California partner issues the Colorado partner a W-2 each year (apparently for administrative convenience).


Concerns:
1. Does acceptance of the W-2 automatically relegate Colorado partner to employee status?
2. Can a person be both a partner and an employee at same time?
3. WHAT IF SCENARIO: Colorado partner dies. Spouse of Colorado partner wants share of the partnership. Can California partner say "Too bad, spouse, you get nothing because Colorado partner was really an employee, not a partner -- he got a W-2 each year, so that proves it" ???

Thanks for any insight into this.

 

[Zigner]

One would need to review the partnership agreement to find the answers to your questions. One might need to retain an attorney for assistance.

 

[zddoodah]

Are you the CA partner or the CO partner?

Colorado resident has a website business with one other person, a California resident.
California partner and Colorado partner split the profit 50/50.

Is there a written partnership agreement?

The California partner does all the bookkeeping.
The California partner issues the Colorado partner a W-2 each year (apparently for administrative convenience).

"For administrative convenience" doesn't make much sense in this context. Sounds like the CA partner may not know know what he/she is doing.

Does acceptance of the W-2 automatically relegate Colorado partner to employee status?

What does "acceptance of the W-2" mean? Regardless, the answer to the question is no.

Can a person be both a partner and an employee at same time?

Yes (although it would be uncommon).

WHAT IF SCENARIO: Colorado partner dies. Spouse of Colorado partner wants share of the partnership. Can California partner say "Too bad, spouse, you get nothing because Colorado partner was really an employee, not a partner -- he got a W-2 each year, so that proves it" ?

Anyone can say anything that one wants. What does the partnership agreement say will happen to the partnership interest of a deceased partner?

 

[Taxing Matters]

Concerns:
1. Does acceptance of the W-2 automatically relegate Colorado partner to employee status?

No. What determines whether one is an employee depends on the relationship the person has with the purported employer. Assuming you are a general partner of the partnership then being also an employee, while possible, is very uncommon. If you are an active 50% partner you almost certainly are NOT an employee and should not be getting a W-2. Are you also getting Form K-1 to report your share of the partnership profit/loss?

2. Can a person be both a partner and an employee at same time?

Yes, but for a general partner with a substantial interest in the partnership that's extremely unusual and the chances are your situation doesn't fit with those where you would be an employee.

3. WHAT IF SCENARIO: Colorado partner dies. Spouse of Colorado partner wants share of the partnership. Can California partner say "Too bad, spouse, you get nothing because Colorado partner was really an employee, not a partner -- he got a W-2 each year, so that proves it" ???

He could say that. Whether it would be successful for him depends on all the facts. First and foremost: do you have a written partnership agreement? If the answer is no, then you need one ASAP. A well drafted partnership agreement will set out how the partnership will work and deal with things like what happens should a partner die, get divorced, go bankrupt, etc.

 

[THS Warrior]

Situation:
Colorado resident has a website business with one other person, a California resident.
California partner and Colorado partner split the profit 50/50.
The California partner does all the bookkeeping.
The California partner issues the Colorado partner a W-2 each year (apparently for administrative convenience).


Concerns:
1. Does acceptance of the W-2 automatically relegate Colorado partner to employee status?
2. Can a person be both a partner and an employee at same time?
3. WHAT IF SCENARIO: Colorado partner dies. Spouse of Colorado partner wants share of the partnership. Can California partner say "Too bad, spouse, you get nothing because Colorado partner was really an employee, not a partner -- he got a W-2 each year, so that proves it" ???

Thanks for any insight into this.

You are confusing terms that are not dispositive of anything important.
1. All partnerships should have a written partnership agreement that spells out the answers to all of your questions about partnerships.
2. If the partners (there can be as many as wanted) agree to "hire" each other and pay the payroll taxes and other stuff that goes along with being a "W-2 employee" that is what will happen.
3. If one, some or all partners decide that they want to be "1099 employees" of the partnership they should hire counsel first. (Note: If I was the partnership's lawyer that would never happen under my watch.)
4. Spouses: Unless the surviving partners want to extend a NEW partnership to the spouse of a deceased partner the spouse is out of luck--unless the partnership AGREEMENT says otherwise.
5. Receiving a W-2 each year is a ministerial act; it does not "prove" anything.

 

[Taxing Matters]

2. If the partners (there can be as many as wanted) agree to "hire" each other and pay the payroll taxes and other stuff that goes along with being a "W-2 employee" that is what will happen.

Except that under federal tax law general partners doing work for their partnerships are not employees. As the IRS explains:

Bona fide members of a partnership are not employees of the partnership within the meaning of the Federal Insurance Contributions Act, the Federal Unemployment Tax Act, and the Collection of Income Tax at Source on Wages (chapters 21, 23, and 24, respectively, subtitle C, Internal Revenue Code of 1954). Such a partner who devotes his time and energies in the conduct of the trade or business of the partnership, or in providing services to the partnership as an independent contractor, is, in either event, a self-employed individual rather than an individual who, under the usual common law rules applicable in determining the employer-employee relationship, has the status of an employee. Sections 1402(a) and 3121(d)(2) of the Code.​

​

Rev. Rul. 69-184, 1969-1 C.B. 256 (1969). Thus, a general partner should not be paid "wages" and given a W-2 for the work the partner does for the partnership, and the partnership cannot deduct such payments as wages paid to employees.

3. If one, some or all partners decide that they want to be "1099 employees" of the partnership they should hire counsel first. (Note: If I was the partnership's lawyer that would never happen under my watch.)

I agree it's a good idea to consult counsel on this. It is possible for a general partner of a partnership to provide independent contracting services for the partnership for federal tax law purposes, or to be paid guaranteed payments for services given the partnership, but that has to be compensation other than the partner's share of the partnership income. A partnership wanting to do that should consult a tax attorney or other tax professional familiar with partnership taxation first to be sure it gets it right in addition to any advice it gets from its business attorney.

I would not rule this out treating a partner as an independent contractor in all cases as you apparently would, however.

4. Spouses: Unless the surviving partners want to extend a NEW partnership to the spouse of a deceased partner the spouse is out of luck--unless the partnership AGREEMENT says otherwise.

I agree that a well drafted partnership agreement is important. In Colorado, it is indeed possible for a spouse (or any other heir or devisee for that matter) to inherit the decedent spouse's share of the partnership if the partnership agreement is silent on the issue. And there are other life events for a partner that might result in transfer of a partner's partnership interest (e.g. divorce, bankruptcy, etc). For that reason, a well drafted partnership agreement will specifically state what will happen should a partner die, get divorced, go bankrupt, etc.

 

[LdiJ]

I would like to point out an alternate scenario...

Lets say that it's an LLC that has made an S-Corp election, even though they regard themselves as a partnership. Then, let's say that one of the partners is an active participant in the business and therefore is required to be treated as an employee of the S-Corp and the other "partner" is not.

It's not a simple situation. The exact details matter...

 

[Taxing Matters]

I would like to point out an alternate scenario...

Lets say that it's an LLC that has made an S-Corp election, even though they regard themselves as a partnership. Then, let's say that one of the partners is an active participant in the business and therefore is required to be treated as an employee of the S-Corp and the other "partner" is not.

It's not a simple situation. The exact details matter...

Right. My previous response regarding tax treatment was based on the business being classified as a partnership for federal tax purposes. If it is classified instead as a C or S corporation then the answers change.