Restaurant Law Blog

Thursday, January 9, 2014

Reminder: LLC Members Are Not Employees and Cannot be Paid Traditional Salaries

The following was written by Guy Alessandro, CPA and a well-respected colleague of mine.

By definition of law LLC members are not employees, they are self-employed. They are not eligible to be paid as employees and issued W-2 forms at year end. Members that draw salaries must do so without tax withholding and are personally responsible for all taxes. Member salaries are reported annually on form K-1 as “Guaranteed Payments to Partners”.

Typically, members draw non-payroll salary checks without withholding taxes and then personally pay quarterly federal and state estimated tax payments. Some members find this process inconvenient, costly (paying the accountant to calculate quarterly payments) and unsettling compared to withholding and remitting taxes every week through the payroll system.

Since the income tax result is same, some LLC members have chosen to pay themselves through the payroll system.  However, we strongly recommend that you do not do this for the following reasons:

  • It is not in compliance with the law
  • If the LLC has a loss, the company winds up paying some or all of its ½ share of the SE tax unnecessarily
  • Federal and state unemployment tax will be paid unnecessarily (About $400 per year per member)
  • It incorrectly shifts the tax burden for ½ of the SE tax from the member to the company
  • If the company fails to pay its payroll taxes, the IRS could take the position that the member still owes it ½ of the SE tax (plus interest and penalties).
  • Member compensation is not deductible for NYC Unincorporated Business Tax purposes. When members are paid through the payroll system, their compensation shows up in the wrong place on the company’s federal tax return and does not “flow through” properly to the company’s NYC Unincorporated Business Tax return, causing an understatement of NYC Unincorporated Business Tax return liability.

While the convenience of an automatic weekly paycheck with weekly withholding cannot be maintained, we can recommend some ideas to make this process easier for LLC members:

  • Draw your salary through your payroll service as a “1099” vendor without withholding (Be sure to tell your payroll service NOT to generate an actual form 1099 at year end).
  • Have the pay split into two amounts, using an appropriate estimated tax % (e.g. if estimated total taxes will be 40%, split a $2,000 weekly salary $1,200 / $800)
  • Use direct deposit through your payroll service to deposit the “tax” amount into a personal savings account and the “net” amount into a personal checking account
  • Each quarter, transfer the funds from your savings account to your checking account and make estimated tax payments to the IRS and New York State.

Alternatively, you could simply write company checks to the members and employ the same splitting technique, with each member depositing one check to a personal checking account and another to a personal savings account.

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