ASK THE CALIFORNIA EMPLOYMENT TAX AND PAYROLL TAX ATTORNEY – IS A CORPORATE OFFICER ALWAYS AN EMPLOYEE?
By Robert S. Schriebman
2024
Introduction
A substantial portion of my tax law practice is representing small and medium sized corporations before the EDD. I see much misinformation and abuse of the shareholder-entity relationship. It is not uncommon to see the owner-shareholder taking out funds from the corporation and treating them as a loan or not issuing Form W2. Instead, the shareholder receives a Form 1099. This pattern of behavior is a delight to an EDD auditor who will issue a stiff tax assessment together with several penalties including penalty for not filing payroll tax returns, the negligence penalty and harsh worker information return penalties. The corporate owners’ defense is usually pointing the finger of guilt at his/her CPA or tax return preparer. When I explain that the shareholder should have received a W2 instead of a 1099, I get a “deer in the headlights” response. They cannot understand what they did wrong. They often ask, “Why can’t I be an independent contractor?”
In this article, I will explain the law relating to the corporate officer vis-a-vis his/her corporation and show you where it may be permissible for the corporate officer to be both an employee and an independent contractor.
The Corporate Officer as An Employee
Let’s start with the fundamentals. What does employment mean? Who is an employer? Who’s an employee? With the enactment of the ABC Test, the laws relating to employment became very narrow, especially when a service provider wanted to be treated as an independent contractor. There are many articles on this website that get into the details of the notorious ABC Test and its many exemptions. This is not the place to discuss these matters.
Generally, employment occurs when an employer hires an employee to perform services for wages.
An employer can be a sole proprietor, corporation, partnership, LLC, etc. The key statute in the EDD Code (CUIC) is § 621(a).
Who is an employee? According to the CUIC and specifically § 621(a), defining “employment,” an employee is initially as any officer of a corporation. In this respect, the EDD and the IRS follow the same rules. It seems to be clearly spelled out and not open to much discussion. Aside from this simple definition, determining who is an employee is today a complicated endeavor. We have the definitions of “employee” in CUIC § 621(a) but we also have AB-5 and AB-2257 with the ABC Test and its many exemptions.
The Corporate Officer as an Independent Contractor
Taking a look at the complex body of law in determining the definition of an employee under all of the above tests, is the definition under the original CUIC § still viable? In my opinion it is. There is a blessing in this simplicity but also a curse. The curse is inflexibility. The typical EDD auditor believes that section 621(a) is set in stone – there are no exceptions and no room for treating a corporate officer as an independent contractor. Most EDD auditors will not entertain any argument or evidence showing a corporate officer to be anything other than a statutory employee; “forget about it.”
However, there are valid exceptions. When a corporate officer goes above and beyond his/her routine job descriptions, it is possible for that officer to be treated as independent contractor for those extraordinary services.
In the body of legal decisions issued by the CUIAB, there are both regular decisions and precedent decisions. The precedent decisions are binding on the CUIAB as if they were statutes passed by the Legislature. One such example comes to mind.
In precedent decision 406 the sole shareholder of an insurance agency was treated as both an employee for his routine services, and as an independent contractor when he solicited insurance sales revenue on the weekends. According the CUIAB, “The Petitioner may engage the services of its officers as independent contractors in regard to separate transactions not involving their administrative duties on behalf of the corporation.”
Conclusion
Taking compensation from your corporation or LLC for routine management and administrative services will always be treated as wages. For this a W2 must be issued, not a 1099. Going above and beyond the routine may very well be treated as the services provided by an independent contractor.
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Robert Schriebman has a successful practice in the Rolling Hills Estates area of Los Angeles County serving clients throughout California and the United States. He has successfully dedicated more than 50 years to helping individual taxpayers, business owners, CPAs, Enrolled Agents, and tax attorneys navigate the complicated tax systems of the federal and state governments. Mr. Schriebman is in private practice. He is not affiliated in any way with the EDD, and he is not employed by the EDD or any other agency of the State of California.
Robert Schriebman has written the only 2 books ever published dealing with how California Employment Development Department (EDD) operates. See “California Tax Collection Practice and Procedures” and “California Taxation Practice and Procedure,” both published by Commerce Clearing House.
Robert Schriebman has written over 20 books including the major manual used nationally by practitioners and the IRS, “IRS Tax Collection Procedures – A Manual for Practitioners” published by Commerce Clearing House.
Robert Schriebman has written over 20 books including the major manual used nationally by practitioners and the IRS, “IRS Tax Collection Procedures – A Manual for Practitioners” published by Commerce Clearing House in addition to the only 2 books ever published dealing with how California Employment Development Department (EDD) operates. See “California Tax Collection Practice and Procedures” and “California Taxation Practice and Procedure,” both published by Commerce Clearing House.
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