Question 333: I ran across a situation I have not seen previously with a pass-thru LLC. A doctor is receiving 1099 income, which he "passes thru" an LLC. He also has employees, paid as W-2 employees of the LLC. I am not sure I understand the purpose of the LLC, and why he is not just getting a W-2 from the LLC. Do we have two entities here -- the LLC and an independent contractor? Which is the sponsor of the 401(k) plan?
There are two pivotal questions. First, did the LLC elect to be taxed as a corporation? It elects to be taxed as an S Corporation if it files Form 2553 with the IRS. It elects to be taxed as a C Corporation if it files Form 8832 with the IRS. If it elected to be taxed as a corporation, then it is treated as a corporation, and the doctor is a shareholder/employee for payroll tax and retirement plan purposes. The “corporation” would record the doctor’s compensation on Form W-2, which can be the basis of a retirement plan contribution, just as it can with any incorporated professional. Generally, the answer to this first question is “no.” Most LLCs do not elect to be taxed as corporations.
If the LLC has not elected to be taxed as a corporation, then we come to our second question. Does the LLC have only one owner? If the answer is no (there is more than one owner), then the LLC is treated as a partnership. The doctor should receive a K-1, not a W-2. But your question suggests that the answer here would be yes, because the doctor is the sole owner.
In that case, the LLC is disregarded as a separate entity. It is simply a manifestation, if you will, of the doctor’s sole proprietorship. From a tax standpoint, it might as well not exist. (However, there may be outstanding reasons from a state law standpoint to have the LLC.) Does a sole proprietorship issue a W-2 to its owner? Heavens, no. The doctor would report both the 1099 income and the other LLC income on Schedule C of the doctor’s personal return. Whether the receipts run through an LLC checking account along the way does not matter for tax and plan purposes.
For more information, see Chapter 2 of my book, ‘Who’s the Employer.”