Is a Partner in an LLC an Employee?

In the business world, it is common to see a company's name followed by the initials LLC. LLC, an abbreviation for limited liability company, is a way for individuals to form a legal entity to conduct business. But are those individuals, sometimes known as partners, considered employees? The short answer to this question is—it depends.

Partners and owners in an LLC are generally referred to as members. “The partners are considered owners of the business and so they are not technically employees since they share in the gains and losses of the business (and invest capital)," says Falen O. Cox, a Georgia-based attorney and partner in the law firm Cox, Rodman & Middleton LLC.

Generally, a partner cannot be an employee of the LLC, but there is an exception. “Members can be employees of the LLC if there is an employment agreement in place where members are providing services to the LLC in exchange for salary and compensation," says Corinne Chen, attorney at Romano Law in New York.

Also, if an LLC is taxed as a corporation, the LLC can choose to hire its members as employees who are paid salaries. The salary must conform to reasonable industry standards.

How does a member get paid by an LLC?

“In most LLCs, profit distribution is based on each member's proportional ownership interest," Chen says. Some LLCs elect an entirely different approach, and this is usually outlined in the LLC's operating agreement.

An LLC is a “pass-through" organization in terms of taxes. “This means the members pay the taxes instead of the LLC itself," Chen says. If it is a multi-member LLC being taxed as a partnership, the members of an LLC cannot be paid a salary. “Profits generated throughout the year are distributed to each member as income to be reported to the IRS," she adds. In terms of taxes, members have to pay taxes on the amount of profit that constitutes their share even if they do not withdraw this amount.

What if your LLC has multiple members?

It is possible to start an LLC with multiple members or add additional members as the company grows. The LLC's operating agreement dictates “how members can be added, whether there are different classes of members, the rights and authorization in different membership classes, and what capacities or titles and responsibilities each member has within the LLC," Chen says.

How does a multi-member LLC work?

“Members in a multi-member LLC can be individuals, LLCs, or corporations. In most circumstances, only one person or entity is named as the manager," Chen says. The members in a multi-member LLC have liability protection between their personal assets and business. This protection extends to lawsuits and business debt.

Multi-member LLCs are taxed as a general partnership. This means that members pay the full amount of taxes payable on the LLC's income. However, multi-member LLCs can request to be taxed as an S corporation by filing Form 2553 or as a C corporation by filing Form 8832.

How do you form a multi-member LLC?

Individuals who want to form a multi-member LLC do so because of tax benefits and liability protection. Guidelines vary from state to state, so be sure to consult your state's guidelines to confirm multi-member LLC requirements. Here is a general outline of the process.

1. Establish the basics. Check availability of the desired entity name with your state's secretary of state website. Determine what business licenses and permits you may need.
2. Draft and file the LLC's articles of organization.
3. Apply for an Employer Identification Number.
4. Draft and have all members execute an operating agreement (especially if it is a multi-member LLC).
5. Hold an initial annual members' meeting according to the operating agreement, or execute an initial members' resolution authorizing actions taken by members or managers (such as opening a company bank account).
6. Open a separate bank account for the business. And remember to keep the funds separate from any personal accounts and transactions.