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Answers are provided by S. Derrin Watson, JD, APM
LLC Members as Employees
(Posted April 8, 2003)
Question 254: When is a member of an LLC considered self-employeed? Suppose Ilene is a member of an LLC who manages its staff, calculates payroll and does general accounting but does not get paid for her time. She has no IRS Form 1099 or W-2. Is she considered an employee, self-employed or just a member who works for free?
Answer: First and foremost, whenever you deal with an LLC, you must learn how the LLC is taxed. Most LLCs with more than one member are taxed as a partnership, but some have chosen to be taxed as a corporation. LLCs with a single member are disregarded as separate entities (e.g., taxed as a sole proprietorship) if they do not elect to be taxed as a corporation. (Q 1:7. References to "Q" are to numbered questions addressed in the 3rd edition of my book, Who's the Employer; they can be viewed online by subscribers.)
Let's assume this LLC is taxed as a partnership; the owners hence are treated as partners. It doesn't matter whether they have W-2 or 1099 income. In fact, it would be wrong for an LLC that's taxed as a partnership to give a W-2 or a 1099 to one of its members. (Q 1:14.) Instead, the partner's income is based on the K-1 from the LLC to the partner.
Like other partners, an LLC member has net earnings from self-employment, as shown on the K-1. (Q 1:11.) From your description, it sounds like Ilene's services are a material income-producing factor, so she would be a self-employed individual. (Q 1:10.) Similar reasoning would apply if she were treated as a sole proprietor.
What if the LLC is taxed as a corporation? In that case, it sounds like Ilene is an employee of the corporation, an unpaid employee. Even if the LLC is taxed as an S Corporation, Ilene's compensation would be zero, because S Corporation dividends are not compensation for plan purposes. (Q 3:1.)
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