A common mistake (often most applicable with small businesses) is the issuance of a Form W-2 to a partner in a partnership. Surprisingly, tax advisors continue to see partners treating themselves as employees. Today, more small businesses are offering profits interest as a form of compensation to their employees at all levels, which terminates the employee status in the eyes of the IRS.
When an employee becomes a partner, payroll withholding becomes his or her own financial burden and filing obligation. Previously responsible for withholding and remitting the employment taxes of that employee, the employer must now report guaranteed payments on Schedule K-1 to the partner as opposed to issuing a W-2. Through his or her receipt of a profits interest, the partner is now responsible for making quarterly estimated payments to the IRS.
Both partners and employees should be aware of these changes when capital or profits interests are awarded as a form of compensation. If you are a partner and have received a W-2, you should consult with your tax advisor for the appropriate steps to correct your filing and withholding obligations for 2015.
If you have further questions regarding partnerships, please feel free to reach out to me (email@example.com) or one of my colleagues.