Is a Partner in an LLC an Employee?

Is a Partner in an LLC an Employee?

by Brette Sember, J.D., December 2015

LLCs are a unique animal in the business world. Understanding the state and IRS rules about LLC members and employment is important when setting up and running your LLC.

LLC Member Employment

Is a partner in an LLC an employee? LLC members are technically not LLC partners or LLC employees. Those who own an LLC are considered to be owners or members under state laws. If you are an owner you obviously do work for and with the LLC, but you are not considered to be an employee.

How LLC Members Are Paid<

In general, LLC owners are paid a percentage of the profits of the company, not salaries or wages. The LLC operating agreement lays out each member’s percentage of ownership. A member of an LLC receives that same percentage of the profit. The member LLC does not receive a W-2 or a paycheck for this income. LLC member profits and losses are treated as personal income for LLC taxes purposes. LLC members must pay the self-employment tax on this income. The exception to this is members who are not active in the business and who are only investors and not involved in making decisions. These types of members may not be subject to self-employment tax.

LLC Taxation

An LLC is a pass-through organization for tax purposes, meaning the members pay the taxes instead of the LLC itself. LLCs are not recognized by the IRS, so the LLC itself can choose how it wants to be taxed by the IRS. If you are the only member, then your LLC can be taxed as a sole proprietorship or corporation. If there are two or more members, your LLC can choose to be taxed as a partnership or a corporation.

Corporation Employees

There is one exception to the rule about members being employees. If your LLC chooses to be taxed as a corporation, the LLC can choose to hire its members as employees who get paid a “reasonable” salary according to industry standards. If you provide services to the LLC or on behalf of the LLC for guaranteed payment, this income is considered employment income by the IRS. It is important to read your state regulations about designating a member as an employee, because these rules are state specific and can change each year.

If you become an employee, the salary you receive is subject to standard federal withholding taxes, and not to self-employment taxes, which can provide a significant advantage to you.

Another option is to hire your spouse as an employee of the LLC and pay him or her a salary, which will reduce the LLC profits and reduce your own self-employment tax. This has to be done correctly and legally though and the spouse has to actually perform the duties of an employee.

It’s important to clarify your role within an LLC and how you will be paid. You also need to understand how you will be taxed on your LLC income so that you can comply with the law.

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