Coverage of Shareholders/Members

[Guest djsimonetti]

All employees of C corp (including shareholders) are covered by 125 plan. In future, C corp's business will be conducted by a new LLC whose members are the shareholders and which will hire employees of C corp. As members of LLC, shareholders are self-employed and can't participate in LLC's 125 plan. Can shareholders stay employed by C corp, be leased to LLC and continue to particpate in C corp's plan? If so, will C corp's plan pass concentration test (even though it has no non-key employees) because it is aggregated with LLC's plan under 414© and(m)?

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[Guest John Nelson]

Why do you necessarily assume that "members" cannot be employees? If member is paid wages from LLC and receives a Form W-2 at the end of the year, I think he/she is an employee and, accordingly, can participate in the 125 Plan. What am I missing here? Thanks for your help.

[Guest djsimonetti]

The IRS has taken the position that an individual cannot be a member and a common law emplyee of an LLC (or a partnership for that matter). If an individual owns a membership interest, he will be treated as self-employed.

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[Guest John Nelson]

Just a quick follow-up: I see where under proposed regulations to Code section 1402 (published on 1/13/97) the IRS has set forth rules for determining whether an LLC member's distributive share is or is not subject to self-employment tax. But, there is an old regulation under Treas. Reg. section 1.401-10(B)(3)(i)which states that "an individual who is a common law employee is not a self-employed individual with respect income attributable to such employment, even though such income constitutes net earnings from self-employment as defined in section 1402(a)". In other words, "if it walks like a "common law employee", and quacks like a "common law employee", it's a "common law employee". Thus, it seems to me that a "member" of an LLC can also be an employee of that LLC even though his income from the LLC may be considered self-emlployment income. I think, for example, that if the LLC continues to pay him a salary and issue him a W-2 at the end of the year, he can participate in the 125 plan.

Let me know what you think. Thanks.

[BeckyMiller]

See Revenue Rulings 70-411 and 69-184. The reference in the old regulation is for persons who are common law employees, but subject to SE tax, such as ministers on their parsonage allowance, certain insurance sales people, etc.

I agree with Simonetti, if the LLC is being taxed as a partnership, the partner members' income must be reported on a K-1, as distributive share of income, guaranteed payments or whatever. They do not get a W-2.

With respect to your question about retaining the owners as common-law employees of the C corporation, I guess I am a little confused about what is happening. Is the LLC going to be owned by the C corporation or by the current shareholders? If the current shareholders are not going to own it, then they would not be partners and the prior discussion would not apply. Under the 7701 or 7702 (can't remember) regulations, an LLC that is wholly owned by a corporation is disregarded as a separate entity for tax purposes and treated merely as a division.

Need more information.

[Lisa Hand]

For federal tax purposes, LLCs are generally treated as partnerships. Thus, member/owners can not participate in a cafeteria plan. Setting up a structure with the intent to circumvent this rule would probably not stand up to audit.

[Guest timb]

If there is no minimum ownership threshold, is there some other argument that can be raised? I know of an LLC with a cafeteria plan that is taxed as a partnership. Probably 2/3 of the 200 or so employees own a few shares in the LLC. Most own less than 1/2 of 1% of the company. They receive both a K-1 and a W-2.

Does owning a few shares in the company prevent them from participating? They're rank-and-file employees. Perhaps more importantly, does any "employee" with an LLC membership interest have to pay self-employment tax, receive only K-1's (no W-2), etc. - all the trappings of partnership?

[Kirk Maldonado]

While I generally agree with Becky Miller, I have a question.

What if the member of the LLC receives a fixed salary (regardless of the level of profits)? Would that be treated as a guaranteed payment to a partner? If so, would that enable the person to participate in the cafeteria plan to the extent of the guaranteed payments?

[Guest timb]

I don't know whether the salary would be treated as a guaranteed payment. If it is, however, Treas. Reg. §1.707-1© states that "... a partner who receives guaranteed payments is not regarded as an employee of the partnership for the purposes of withholding of tax at source, deferred compensation plans, etc."

125 plans are not specifically mentioned, although it seems that this logic would also exclude employees from the 125 definition of employee (as to guaranteed payments).