Owner of single member llc paid himself on payroll and issued w2. is this ok? If not OK, how is this best corrected?

[KrisD15]

Yes. You can setup a SEP plan or Solo 401K.

The deadline for contributing is extended along with the tax filing deadline to July 15th, 2020.

IRS link on SEP

Solo 401k

[mark-makuch]

I agree with this and have understood it to be so for my whole career, but when I was challenged to back it up recently, I could find lots of posts like your answer, from self assured accountants like myself, but I actually couldn't find it written down anywhere official, in an IRS pub or the Code or Regs.   I see things that say 'you're subject to SE tax', but nothing that specifically says 'you may NOT pay yourself as an employee' and it would be helpful to be able to point people to such a thing.   Do you have a cite, or are you like me and you just have always trusted that this is so?

[RobertG]

If you are an LLC that has not elected to be treated as a corporation, you are either a partnership or a sole proprietorship.

Partners are not employees and should not be issued a Form W-2 in lieu of Form 1065, Schedule K-1, for distributions or guaranteed payments from the partnership.  https://www.irs.gov/businesses/small-businesses-self-employed/paying-yourself#2

You cannot deduct your own salary or any personal withdrawals you make from your business. As a sole proprietor, you are not an employee of the business. https://www.irs.gov/publications/p334#en_US_2019_publink100033111

[tagteam]

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@mark-makuch wrote:

....I see things that say 'you're subject to SE tax', but nothing that specifically says 'you may NOT pay yourself as an employee' and it would be helpful to be able to point people to such a thing.   Do you have a cite, or are you like me and you just have always trusted that this is so?

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There is no definition of "employee" in the Code, to the best of my knowledge, but an individual is deemed to be an employee if that person meets the requirements set forth in Treas. Reg.  §31.3401(c)-1.

I would also refer you to Rev. Rul. 87-41.

Further, I doubt whether the IRS could more clear on this issue in the following topic relating to partnerships. 

https://www.irs.gov/businesses/small-businesses-self-employed/partnerships

[mark-makuch]

Thank you  but as far as I can tell you're still leaving us at the same place, where one might infer that a sole proprietor or single member llc owner can't put himself on payroll, but it doesn't explicitly say that.   Keep in mind I agree with your inference, but sometimes we are all challenged by clients who say 'where does it specifically say that I can't put myself on payroll' and I don't see where either of those links leads to a statement anywhere near that clear.   Again, I agree you're not supposed to do it.   But I'd like to see it spelled out for support.  If you can point me to specific language in those cites that gives a clear answer, please do.  I don't see it.

[tagteam]

Treas. Reg. § 31.3401(a)-1(a)

(1) The term “wages” means all remuneration for services performed by an employee for his employer unless specifically excepted under section 3401(a) or excepted under section 3402(e).

Obviously, if you are a sole proprietor (or have a single-member LLC), you cannot be both an employee and an employer; you are self-employed and must pay self-employment tax (and generally make estimated income tax payments).

See https://www.irs.gov/businesses/small-businesses-self-employed/self-employed-individuals-tax-center

[mark-makuch]

This is more of the same.   You can say it's obvious all you want, it's not a cite and it's not an example of an explicit rule.   It's obvious to me that an investment fee is an ordinary and necessary business expense of a trust, but it's not deductible.  The reason is that there's a rule.  

[tagteam]

It most certainly is a cite - to a Treasury Regulation. I suggest you read that Reg.

[mark-makuch]

Yes.  I've read it.  Please point out the part where it says a sole proprietor or person organized as a single member llc can't put herself on payroll.   Keep in mind that same person organized the same way (but choosing to have her single member llc treated as an s corp for tax purposes) can so it's not simply logical, like I can't be both employee and employer, because that's plenty possible.    So where in 31.3401 does it specifically say a person can't be an employee of her single member llc?

[VolvoGirl · Accepted solution]

You cannot deduct your own salary or any personal withdrawals you make from your business. As a sole proprietor, you are not an employee of the business.

Sole proprietors cannot take a withdrawal or salary and include it as an expense on their tax return. As a sole proprietor, you are not an employee of the business. You don't pay yourself or enter a salary or withdrawal for yourself. All the business income and expenses are your personal income and expenses in the first place. You just fill out a Schedule C. The net profit or loss is your income.  If you have a net profit of $400 or more on schedule C you will pay SE self employment tax on it in addition to your regular income tax. It's all included on your personal 1040 form.  

(And if you paid yourself and deducted it as an expense then you would have to include it as income on the same tax return so it would be a wash.)

See Schedule C instructions page C-10 right above line 30, Do not include….amounts paid to yourself

http://www.irs.gov/pub/irs-pdf/i1040sc.pdf

[tagteam]

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@mark-makuch wrote:

...Keep in mind that same person organized the same way (but choosing to have her single member llc treated as an s corp for tax purposes) can so it's not simply logical, like I can't be both employee and employer, because that's plenty possible. 

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That is because the S corporation is not treated as a disregarded entity (as is a single-member LLC).

The S corporation is an entity separate and apart from its shareholders, even if there is only one shareholder. Therefore, the sole shareholder can be an employee of the S corporation (or an LLC treated as an S corporation for federal income tax purposes). 

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@mark-makuch wrote:

So where in 31.3401 does it specifically say a person can't be an employee of her single member llc?

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Again, an individual cannot be both an employee (which is actually a legal term) and an employer of a sole proprietorship (or single-member LLC that is disregarded for federal income tax purposes).

If you cannot figure that out from the cited Reg, it is because you are using pretzel logic, which might get you somewhere in an academic (and totally useless) argument on the internet, but it will fall absolutely flat with the IRS.

[VolvoGirl]

You don't need to issue yourself a W2 for taking money out of your business.  It's all your money in the first place.  It's not an expense.  You pay your own employment payroll taxes with the self employment tax on your Net Profit.  

 Self Employment tax (Scheduled SE) is automatically generated if a person has $400 or more of net profit from self-employment.  You pay 15.3% SE tax on 92.35% of your Net Profit greater than $400.  The 15.3% self employed SE Tax is to pay both the employer part and employee part of Social Security and Medicare.  So you get social security credit for it when you retire.   

[mark-makuch]

Okay again, and I don't think you read or maybe didn't understand the original question, but I agree with you, in that I make the same assumption.   I wasn't questioning the assumption or conclusion, I was asking if it's explicit anywhere.  So you sent a cite and I asked what portion of that cite is the explicit answer to my question and you said 'well if you can't figure it out...' which is bringing us back to the original question.  I can figure it out and draw a conclusion, but sometimes clients (and even payroll companies) want an explicit answer before they stop and correct a practice they've been doing for years without ever having a problem (and yes, that happens, sole proprietors and single member llcs pay their owner on a W2 without ever having it challenged and then I come in and tell them to stop and they understandably want a solid reason).   So when I ask for a cite which is explicit, and you provide one and I say where in that is it explicit and you say 'figure it out' what you're saying is "no, I do not know of any place where it says it explicitly" and to be honest in that case, and this is a problem on this forum, if you don't know the answer or don't have the answer, it would be more efficient to not answer.   There are so many people who don't read the question or don't have an answer but just can't resist posting anyway and it's a waste of time.   So the conclusion after all this is 'no, there's no explicit prohibition on issuing yourself a W2.  You have to read between the lines'   Got it, thanks.

[mark-makuch]

I totally agree with you, and I think your post is the closest to explicit so I thank you.  The problem I've had using the schedule c instructions are that first of all people come back to me with 'they're talking about draw when they say that, not payroll with taxes withheld' and second of all neither schedule instructions nor publications are cites.  Only the Code and Regs.   So while what you say is logical and persuasive, I was hoping there was something more concrete for situations when people challenge that as not enough (and they do).   Thanks though this is by far the closest we've come to an answer and I appreciate it.

[tagteam]

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@mark-makuch wrote:

I was hoping there was something more concrete for situations when people challenge that as not enough (and they do).  

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Why not simply inform them that an employer and an employee cannot be the same person (or entity in the case of an employer)? That is clear from the Reg I cited. 

Further, Treas. Reg. §31.3401(c)-1 discusses the term "employee" and delineates among other things, the relationship between an employer and an employee. The Reg also states:

"Generally, physicians, lawyers, dentists, veterinarians, contractors, subcontractors, public stenographers, auctioneers, and others who follow an independent trade, business, or profession, in which they offer their services to the public, are not employees."

In sum, if the individual taxpayer is not an employee, then that taxpayer should not be paid as such and receive a W-2.