An Officer Of A Corporation Or LLC Is A “Statutory Employee”
By Robert S. Schriebman, SJD
copyright 2011. No part of this article may be taken and used in any way whatsoever without the express written consent of Robert S. Schriebman
Are you an officer of your corporation or LLC? If you are the president, CEO, vice president, secretary or CFO of your corporation or LLC, you are deemed to be an officer. Can you be both an officer and an independent contractor at the same time? Are you a “statutory employee”?
A “statutory employee” is defined as an employee under the law and usually under specific federal and California statutes. Most people are not statutory employees. The status of most individuals as employees is determined under what are known as “common law” rules. These common law rules are primarily found in the IRS’s infamous “20 factor” test found in IRS regulations. California too has its version of these factors but has more factors that it takes into consideration other than just 20 factors used by the IRS. Anyone who is found to be a statutory employee must have employment and withholding taxes deducted from his or her paycheck. California has four such taxes: Unemployment Insurance, State Disability Insurance, Personal Income Tax (PIT) and the Employment Training Tax.
In both IRS and EDD audits of small corporations and LLCs we find that the biggest and costliest error made by those running the entity is the treatment of corporate officers as independent contractors. This is absolutely wrong, dangerous and potentially very costly! Many accountants unfortunately have developed a technique whereby they pay out a relatively small amount of compensation to corporate officers and withhold taxes from that small portion. The accountant issues a W-2 for the smaller portion. The rest of the compensation is paid out in the form of a bonus and a 1099 is issued. There are no withholding taxes taken from the 1099 amount. In our opinion this technique is wrong and potentially very costly. We find that when the EDD conducts an audit of the corporation, employment taxes are assessed on the 1099 amount plus severe penalties and interest.
If you are an officer of a small corporation or LLC, you are by law deemed to be a “statutory employee”. You must have federal and state employment and withholding taxes taken from your paycheck; the employer – the corporation or LLC – must pay the employer’s portion of these taxes as well.
Is it possible to be both an officer and an independent contractor? Not likely. The overwhelming majority of people who work as officers of a corporation or an LLC are deemed to be employees under the law. That’s what being a “statutory employee” is all about. Both California and federal law say you must be an employee. There are very rare exceptions wherein a corporate officer will have a very limited and specific job within the corporation and then service the corporation as an independent consultant in other areas. Cases upholding this type of an arrangement wherein the consultant is a real independent contractor are very rare and the odds against success are staggering. This is a practice to be avoided.
When the EDD selects your company for audit and demands the production of your 1099s for the past three years, you can count on an assessment for unpaid employment and withholding taxes, several levels of penalties, together with interest on both the tax and penalty portions. Taking a 1099 as a corporate officer is just flat out wrong. You do so at our peril.