In Now-a-theday’s business environment, businesses find they cannot retain key employees without offering equity interests in the businesses, so partnerships often grant employees interests in organisation  .however, can cause the employee to be treated as a partner, not an employee, for federal tax purposes, while the partnership often mistakenly continues to treat the partner as an employee.

From my review below is one reason which I feel the IRS has repeatedly opposed the treatment of a partner as a partner and an employee.

Often a partner receives a partnership interest solely in exchange for services. The IRS has concluded that the receipt of these interests will not be taxed upon receipt if certain conditions are met.

so long as certain conditions are satisfied, it will not tax a service provider’s receipt of an unvested profits interest (i.e., the interest will be treated as being received as of the date of grant when the value is $0—not at the future vesting date when the value may be significant).

.Because the IRS does not permit a partner to be both a partner and an employee, continuing to treat an employee who has received an unvested profits interest as an employee for employment tax purposes by issuing the partner a Form presumably runs afoul of the above requirement.

Thus, any partner who is treated as an employee at any time after receipt of an unvested profits interest may not satisfy the safe harbor set forth in Rev. Proc. 2001-43, and, thus, the IRS may argue that the issuance of the profits interest ought to be fully taxable upon vesting at the then fair market value.

least one scenario where a partner can be treated as an employee without any consequences.is as below

partnership would pay each partner’s share of any tax due based on the partner’s share of total partnership taxable income for those partners who do not opt out of the composite return. Those partners who opt out of the composite return would receive a Schedule K-1 and report their share of the partnership income on their individual returns exactly as they do under the current system.

Many states already allow partnerships to file a composite partnership income tax return and allow partners the right to opt out of the unified return. For those states that do allow a composite return, the partnership pays the tax on the partner’s behalf and the partner has no other filing requirement in that state. If a composite federal return were allowed, then partners receiving small partnership interests (whether profits or capital interests) could participate in the composite federal partnership income tax return and allow the partnership to pay any tax owed on the partner’s share of partnership profits.