LLCs are not recognized as a taxable entity by the IRS. As a result, the owners of an LLC can choose how the business is to be taxed. How the entity is taxed influences whether an owner who works for an LLC is an employee. If there is only one owner, the LLC can be taxed as either a sole proprietorship or corporation. If there are multiple owners, the LLC can be taxed as a partnership or corporation.
Both sole proprietorships and partnerships are disregarded entities for tax purposes. This means that all of the income and losses these businesses earn during the year is included on the owners’ personal income tax return, whether you received money from the business or not. Sole proprietors and partners are not considered employees. If the LLC decides to be taxed as a sole proprietorship or partnership, the business does not have to pay any employment taxes on wages you earn from that business. You are considered to be “self-employed” and must pay self-employment taxes on your share of the business’s income. You can receive money from the LLC for any work you do, but that is just considered a distribution of your investment in the LLC you have already paid tax on. You would generally not pay additional taxes on the money you received from the LLC for your work.
A corporation is not a disregarded entity for tax purposes, which means the entity pays taxes on any income it earns. Because the corporation is not disregarded, if you work for an LLC you own, classified as a corporation, you may be considered an employee as defined by the Internal Revenue Code. This means the corporation will have to pay half the employment taxes on any income you earn while you pay the other half. Income earned as a result of profit sharing rather than work you directly do for the company may be subject to different taxation requirements.
Since an LLC can be classified as a corporation, it may also qualify as an S corporation for tax purposes. An S-Corp is a corporation that is taxed like a partnership, which means shareholders are taxed on the corporation’s income, not the corporation itself. As with a traditional corporation, if you work for an S-Corp, you are generally an employee regardless of whether you own stock in the business. The S-Corp will also be responsible for paying half of your employment taxes.