Can I get paid to an LLC (or other type of pass-through entity)?
The most popular question I've received since the unveiling of the new tax proposal is, "Can I get paid to an LLC by my employer"? First and foremost, as I've said in previous posts, we have no idea what the final tax plan will look like. So, for now, some gentle review of potential outcomes is worthwhile but don't spend too much time researching anything in particular and certainly don't make any firm tax planning moves based on the one-page proposal from the White House. If you do have to make any decisions now try and choose options that allow for flexibility.
I know, this is really fun, right? Just wait...we might bust out some sparklers later!
The situation: you are an employee of a company and paid a w-2 salary, replete with federal, state and perhaps local withholdings and FICA and FICA MED deductions. You, too, want to pay the proposed 15% federal corporate tax rate! I don't think you'll love the answer.
There are a few issues with having an employer pay an employee as an LLC. You should, of course, contact your friendly tax professional for advice about your specific situation. In general, employers have to follow very specific guidelines about employee classification. In the vast majority of cases, those who work for an employer are employees and must be paid as w-2, salaried employees. An easy, but unofficial, test for employee classification is simply 'Does this person act like a normal employee...do they have a desk, do they have defined hours, etc.'. Very simply put, if it looks like a duck, walks like a duck and sounds like a duck, it's probably a duck (if you're more comfortable using another animal in your analogies, say a badger for example, feel free...the premise doesn't change).
The primary reason for rigid employee classification rules is that the IRS/Social Security Admin does't want to lose out on employer paid employment taxes (FICA, FICA MED). You might be thinking to yourself 'I thought those who receive profits from their LLCs have to pay the FICA and FICA MED via self-employment taxes on their personal returns.' (Kudos if thats what you were thinking...if it wasn't, go do some research and have a 2 page, double-spaced summary paper in my inbox by tomorrow). That thought is, indeed, accurate. Self-employment tax is 15.3% because it is designed to make up for both the employer and employees share of the payroll taxes. However, LLCs aren't the only type of pass-through entity.
S-corporations are a second entity type that passes income (or loss) through to the owner/s. There are several differences between these 2 types of corporations, but we'll just focus on the self-employment tax for now. Profits passed through from S-corps are not subject to self-employment tax. However, S-corps, unlike LLCs, are supposed to issue salaries to it's owners. The salary has FICA and FICA MED withheld and paid by the corporation just as if the owners were employees for any other company would. Owners of S-corps usually receive a combination of salary and pass-through income. The issue with S-corps from a tax collection standpoint under the new tax proposal, which I will barely stick my toe in the water on here, is that owners will try and drive down salaries and jack up pass-through income. This will drive down tax revenue. More stringent guidelines will be needed on the 'reasonable' salary required by the IRS to police this potential issue. This is certainly more complex than that, but it is an issue and it's final presentation will guide tax planning for the coming years.
A final point worth considering: what is lost by not being a w-2 employee and having income paid to a pass-through entity? Medical insurance, transit checks, 401(k) and other employee benefits are available to salaried employees only. Those benefits go by the wayside if you are not paid as a w-2 employee.
The point to all of this...if you want to have your income paid to pass-through entity (LLC, S-corp, etc.), you need to have a legitimate business. If you are an employee of a company and currently receive a w-2 salary, it's highly unlikely that you'll be able to have your income redirected to a pass-through entity.
Here is an article from Bloomberg on this topic as well...sheds some add'l and different light than my musings.
Adam Ditsky, CPA
President, Ditsky Strategic