Are LLC Members Employees?: Everything You Need to Know
Are LLC members employees? Technically, LLC members are neither partners nor employees. LLC owners are considered members, or owners, under state law.3 min read
2. Exception to the Employee Rule
3. More Tax Information
4. Alternative Methods
Are LLC members employees? Technically, LLC members are neither partners nor employees. LLC owners are considered members, or owners, under state law.
LLCs are a unique model in the business world. That's why it's especially important to understand state and IRS rules pertaining to LLC members. If you're an LLC owner, it's safe to say you work for the LLC. Still, under most circumstances you won't be considered an employee.
Profits, Not Wages
Typically, LLC owners are paid a certain percentage of the company's profits, not wages or salaries. A proper LLC agreement will lay out every member's percentage of ownership. Then, they'll receive their allotted percentage of the profit. There are no W-2s or paychecks at any point throughout this process.
As for tax purposes, an LLC member's profits and losses are counted as personal income. If an LLC member isn't active in the business -- only acting as an investor -- he or she may not be required to pay self-employment tax.
One of the reasons LLCs are a unique model in the business world is because they serve as a bit of a pass-through for tax purposes. The LLC itself doesn't pay taxes. Rather, each of the members reports individually.
If you're the only member of your LLC, then you can expect to be taxed as a sole proprietorship or a corporation. If there are other members, then you can expect to be taxed as a partnership of a corporation.
Exception to the Employee Rule
There is one scenario where it's not such a clear-cut line between LLC members and employees. If you opt to be taxed as a corporation, your members may become salaried employees.
So, if an LLC member is providing services to the corporation in return for payment, that income will be considered employment income, which must be reported to the IRS.
Each state has a specific set of rules regarding members and employees. It's paramount to your success that you read them carefully, as they can change every year.
If an LLC member becomes an employee, his or her salary will be subject to federal tax withholding, as opposed to self-employment tax. This may serve as an advantage to that member.
More Tax Information
With regard to federal taxes, no one may be considered both a member and an employee. When most people refer to an LLC, they're referring to one that is being taxed as a partnership.
If someone owns 100% of the equity interests, then the income must be reported on that person's individual income tax return. These funds will be reported as self-employment income from a sole proprietorship.
An LLC member that simply provides services will not be treated as an employee for income tax purposes. Those services will be labeled as "guaranteed payments" to an LLC member and are paid in lieu of wages.
Guaranteed payments are deductible by the LLC. The LLC member who receives guaranteed payments will have to treat them as self-employment income on their federal income taxes.
An LLC may use one of three alternative methods to allow owners who provide a service to be classified as employees. They are:
- Employee Leasing Company
- Separate S Corporation
- Tiered LLC Structure
An employee leasing company requires the formation of a separate employee leasing company which will employ workers with equity interests in the LLC. Essentially, the agency is leasing workers to the LLC. That leasing company will then go on to become a C corporation. The payments made to it are intended to minimize the taxable income faced by the leasing company.
A separate S corporation requires every LLC member that provides services to hold membership interests through an S corporation that's 100% owned by the member. This treats the S corporation as the member, rather than the individual, and makes the service provider an employee of the LLC.
A tiered LLC structure requires the admittance of individuals who provide services to the LLC as members of a separate LLC. In this scenario, the separate LLC, or an investment LLC, will own a membership interest in the LLC, rather than the individuals. Each entity will be taxed as a separate partnership during federal tax season.
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