By:  Amanda Wilson

When deciding how to form their new business, small business owners are often encouraged to organize as an S corporation because of self-employment tax savings. This recommendation is because the IRS does not recognize that a partner in a partnership can also be an employee. As a result, the IRS takes the position that all of the partner’s income from the partnership should be subject to self-employment taxes, instead of just the amount that reflects a reasonable salary.  In contrast, an owner of an S corporation can clearly be treated as both an owner and an employee, resulting in self-employment tax savings.

A lack of guidance in this area has left many taxpayers uncertain as to how they should treat their partnership income, or if they should simply avoid the issue by becoming an S corporation. Recent comments by Clifford Warren, special counsel at the IRS in the partnership area, indicate that the IRS may be issuing definitive guidance on this issue in the future. Whether this guidance will be helpful to taxpayers is not yet clear.