Is a member of an LLC an employee?

For federal income tax purposes, the IRS view is that a partner (or member of an LLC that is taxed as a partnership) cannot be an “employee” for tax purposes and instead must be taxed as a “partner” on their share of the LC’s income. The difference relates mostly to wage withholding and self employment tax obligations and the treatment of benefits. California generally conforms to this rule but, oddly, not entirely. Instead, for purposes of personal income tax withholding, California applies a common law test to determine whether a person is an employee or contractor. Generally, a manager might not be an employee under the common law direction and control test, whereas a non managing member may be more appropriately classified as an employee. The issue will come up more and more as companies choose the LLC choice of business entity and seek to implement equity compensation plans, similar to corporations. Conformity proposals are in the works, but in the meantime, LLCs in California may be required to treat its employee-owners differently for federal and state tax purposes.

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