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One of the top questions we get in the area of corporate governance is whether an officer of a corporation is an employee.
Such a common question should have a very easy answer, right?
So why is it so hard to get a straight answer on this? The reason has to do with the fact that this question is actually a crossover issue blending areas of corporate governance, employee law, tax law, and payroll rules. It sounds like a very simple issue, but it can have a very complicated answer. The answer to this question is important for not only corporate governance reasons, but it can have important ramifications on tax liabilities, payroll matters, and employment law.
The answer to this question is “Generally yes, but it depends,” but to help you understand why, and when an officer of the corporation would NOT be an employee, it is important to discuss the legal issues at play.
Rules are Different for Corporations than LLCs
For a corporation, including a C Corp. and an S Corp., generally, officers are considered employees of the corporation, if they’re being paid to provide services rendered. An officer of a corporation is the person who handles the day-to-day affairs of the organization. So for example, the president who oversees the staff and activities of the business, the secretary who keeps track of the corporation’s records, and the treasurer or CFO who manages the corporation’s finances, are officer positions, and these can be fulfilled through employee positions.
Single-Owner Corporations: When All Officer Positions are Fulfilled by the Business’s Sole Shareholder
For many small businesses, however, there are no outside employees fulfilling these duties. Especially for single owner businesses, where there is one shareholder who plays all 3 roles (CEO, CFO, Secretary). In these cases, what practically happens is that the small business owner fulfills these duties, for no extra or additional pay. The fact that the business owner is not being paid a separate salary for acting as an officer of the corporation has nothing to do with the business owner’s status as an individual who is providing services for the corporation. Any person who provides services for a corporation should be compensated as an employee (or, as explained below, an independent contractor).
This is where the issues cross over from corporate governance into tax law. The IRS generally wants to see business owners who provide services to their corporations being compensated as employees, i.e., through W-2 wages which are subject to payroll taxes. So, what should be happening is that the corporation compensates its business owner for all services, including the services of acting as an officer for the corporation. The reality, however, is that many business owners do not properly pay themselves correctly, and instead take draws (i.e., take a portion of the business’s profits, not subject to payroll taxes to compensate themselves as business owners.) This is not the right way of doing it, and it can trigger an audit on the tax side. For more information, please check out our article on how business owners should be compensating themselves properly, and what steps they can take to minimize their tax obligations.
LLCs: Is the Officer a Member or Outside Hire?
In the LLC context, the question of whether an officer is an employee or not depends on whether the person is a member of the LLC or not. (By the way, this section only applies to LLCs that are taxed as partnerships or sole proprietors, not LLCs that have taken the election to be taxed as a corporation or S corporation).
f the person performing the officer duties is a member, then they will not be an employee and not be considered an employee, because there is a specific IRS regulation that prohibits LLC members from taking wages as employees. On the other hand, if the officer duties are being performed by someone who is not a member of the LLC, such as an outside hire, then they can be characterized as employees.
Why Does it Matter?
The ability to characterize a person providing services to a company as “an employee” is important because it can have important tax consequences. Employee compensation is made pursuant to payroll taxes, and employee wages are considered deductions for tax purposes, and can offset against a business’s gross revenues.
However, depending on the form of the business, such as whether it is a corporation or an LLC, and depending on how the compensation is characterized, it can have important tax consequences for the business.
“Employees” versus “Volunteers” versus “Independent Contractors”
As a final point, it is important to mention that not everyone that provides services to a business is necessarily an employee. This is where employment law comes up. A business can hire health [help?] through a number of ways, whether it is through employment, independent contractor services, or volunteers. Services can be provided through vendors as independent contractors, or through volunteer services. With that said, it should be added that it would be pretty unusual for officer positions of a business to be satisfied through something other than employee services.
Generally, the level of degree and control over the officer negates the legal elements that need to be present for the person to be categorized as an independent contractor; and very few businesses are the type of businesses for which officers provide services for free (for example, in “labor of love” type charities where no person receives any compensation for any services).
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