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

[theresa-thompson]

I don't believe there is any explicit wording to say an LLC owner cannot take payroll as a W2 employee but it seems to be heavily implied when you look at the instructions for line 26 (deduction for salaries and wages paid) it states: ".......do not include amounts paid to yourself". So even if an owner paid themselves on W2 they would not be allowed to include the amount in deductible wages and salaries against the LLC which makes it illogical to pay themselves as a W2 employee.

[tagteam]

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@theresa-thompson wrote:

I don't believe there is any explicit wording to say an LLC owner cannot take payroll as a W2 employee...

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There is the following from the IRS (and note that a multi-member LLC defaults to partnership status if it has not elected to be treated as a corporation for federal income tax purposes):

Partners are not employees and shouldn't be issued a Form W-2.

See https://www.irs.gov/businesses/partnerships

[mark-makuch]

Thank you.

[Anonymous]

another reason . as self-employed you pay the SE tax only on 92.35% of the net income.

an option is to elect to be tax as an S-Corp. see a professional for advice about doing this. it's more complicated and you may not save enough to make it worthwhile. the advantage which may be outweighed by other factors is that you only have to take a reasonable salary and would only pay medicare and fica taxes on it. any remaining income would be taxed to you but no fica or medicare taxes.  

[caremedical]

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. 

this particular statement from IRS does not preclude from some one having W2 in addition to Form1065 from the company. 

I manage a medical group. I have two roles in the company. One is seeing patients like every other physician employee. Second is managing operations of the medical group. 

I have been receiving W2 income similar to everyone in the company based on number of patients seen or number of shifts worked. 

Then the profit is issued as 1065 . and this is in addition to W2. Both of these incomes are computed in 1040 as a pass through entity to compute AGI. 

I am not an accountant and my accountant suggested this is correct way to do it. Recently someone mentioned about restriction for LLC owners not being eligible to have W2 income. I am curious about the interpretation. 

[Mike9241]

 you are not a single member LLC if a 1065 is filed.  you are a partnership.

see this article.  what should be done probably is that some of the payments should be classified as guaranteed payments (those where % ownership in the partnership is ignored)  but W-2's are not issued for guaranteed payments.

https://legalbeagle.com/12716583-can-a-partner-in-an-llc-receive-a-salary.html 

how to fix it - see a pro because this is not only a problem for you but also for any other partner that received a w-2. 

[mark-makuch]

OK so when I posted this original question it was to ask where there is an official IRS cite which says one can't be on payroll as a partner.  I knew that it is generally accepted one cannot do this, and I knew there were a lot of places it was implied or was said in an unofficial place like a pub or the irs.gov website, neither of which are cites which form legal support for a tax position.  So I was like, I know this is how it is, but where does it say it, not colloquially but in a cite?  And people wrote back all kinds of examples of how it says it casually or implies it and said if I can't read between the lines I'm just being difficult.  But as it turns out the question was valid, because the IRS has checked and realized they had never specified it and so they have now issued Revenue Ruling 69-184 to establish officially that partners cannot be employees.   I was right to find it lacking, and I promise to accept apologies graciously 🙂

[mark-makuch]

OK so when I posted this original question it was to ask where there is an official IRS cite which says one can't be on payroll as a partner.  I knew that it is generally accepted one cannot do this, and I knew there were a lot of places it was implied or was said in an unofficial place like a pub or the irs.gov website, neither of which are cites which form legal support for a tax position.  So I was like, I know this is how it is, but where does it say it, not colloquially but in a cite?  And people wrote back all kinds of examples of how it says it casually or implies it and said if I can't read between the lines I'm just being difficult.  But as it turns out the question was valid, because the IRS has checked and realized they had never specified it and so they have now issued Regulations based on Revenue Ruling 69-184 to establish officially that partners cannot be employees.   I was right to find it lacking, and I promise to accept your apology graciously 🙂

[Mike9241]

you do realize that rev ruling 69-184 was issued in 1969 

[tagteam]

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@mark-makuch wrote:

.....the IRS has checked and realized they had never specified it and so they have now issued Revenue Ruling 69-184.....

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They have "now issued"? You do realize that the "69" in the revenue ruling stands for 1969, correct?

Further, there is the following treasury regulation through which you might want to read.

https://www.law.cornell.edu/cfr/text/26/301.7701-2

I am not sure about anyone else, but I am not going to apologize for stating a long-standing rule of tax law.

[mark-makuch]

Read carefully, they just issued Regulations, based on the principle established in 69-184, which now specify the answer to the issue.  The Revenue Ruling is old, the specification (in Final Regulations) is new.

[Darkstar0571]

Yes but that wash is fine? If you set up your books to show that? As people do it so they don't have to pay in estimated taxes, they do it so taxes come out to the IRS so we aren't all screwed 4 times a year with no money to send in for estimated taxes. Will you get in trouble doing that?

[mark-makuch]

I completely agree there are advantages to the employee treatment, and also that there's no real reason to prohibit it as it only helps people to pay the appropriate tax.  I don't know why they forbid it, but they do.  So the answers to your questions are 1) is it okay to do this?  Answer:  No, it's not okay.  2)  Will anything bad happen if you do it?  Answer:  I know people have done this for years without ever having a problem.  I even know of one person who got caught doing it in an audit and told the auditor 'who cares it comes out the same in the end' and the auditor was like 'fine, good point' and let it go unchanged.   So, it's kind of like speeding.  Can you probably get away with it? Yes.  Is it allowed? No.

[Mike9241]

the applicable ruling was issued in 1969. if you are not an employee and you are not if you are the owner of a SMLLC then you can not take a w-2.

there is are good reasons for not taking a w-2.  first you overpay your FICA and Medicare taxes. an employee has up to 7.65% taken out of his paycheck and the employer pays another 7.65 % total 15.3% and the balance of schedule C income id taxed at 15.3% * .9235 or 14.13%. if the result of the W-2 is a loss there is no negative se tax computed so the owner has overpaid. no w-2 then the owner pays the effective rate of 14.13%  assuming the income does not exceed the FICA limit.  another reason, an owner's a w-2 reduces schedule C net income which, if the business qualifies for the full 20% QBI deduction, reduces the QBI deduction by 20% of the gross w-2.

 if audited the IRS may disallow the w-2 deduction not refund the related fica and medicare taxes paid and then hit the owner's 1040 for those taxes + penalties for failure to pay them properly.

want a proper w-2, then incorporate the business - s-corp would avoid double taxation of the income and get you some QBI deduction.   see a tax pro if you think about going this route. there are many things you'll need to learn so the corporate return is a mess and a prime object for audit. 

[mark-makuch]

Yes Mike I agree it is not exactly the same to do one v the other, in some situations one is better, it's all so complicated now there are other situations which are the inverse, but in a larger sense it's often a very similar result to do one v the other.  But you make very good points.