RS 02101: Employer-Employee Relationship - Policies and Procedures
TN 14 (04-12)
Citations:
Social Security Act, Section 1101(a) (3), (4)
A. Common business structures
The most common types of business structures are:
Corporations;
Small business corporations (S corporations);
Limited liability companies;
Partnerships; and
Sole proprietorships.
B. How we define common types of business structures
1. Corporations
A corporation is a business entity.
Many corporations are formed under state corporation laws and are subject to corporate income tax at both the federal and state level.
Other corporations may be formed as limited liability companies under state law, but elect to be treated as corporations for federal tax purposes.
A corporation may be designated as a close or family corporation when the ownership rests in a few persons, a few families, or within a family.
2. Small business corporations (S corporations)
S corporations are corporations that make an election to pass corporate income, losses, deductions, and credit through to their shareholders for federal tax purposes.
3. Limited liability companies (LLC)
A limited liability company is an entity formed under state law by filing articles of organization as an LLC. The members of an LLC are not personally liability for its debts. An LLC may be classified for federal income tax purposes as a partnership, a corporation, or a disregarded entity.
4. Partnerships
A partnership is the relationship between two or more persons to carry on a trade or business.
Each person contributes money, property, labor, or skill, and expects to share in the profits and losses of the business.
A joint undertaking merely to share expenses is not a partnership.
5. Sole proprietorships
A sole proprietorship is the most common form of business organization. Sole proprietors can operate any type of business (full-time or part-time), but not an investment or hobby.
It is simple to develop and offers complete control to the owner.
The owner is personally liable for all financial obligations and debts of the business.
The owner may have net earnings from self-employment subject to self-employment tax.
A business operated through an LLC, which is wholly owned by one individual is be treated for most purposes as a sole proprietorship. The individual may have net earnings from self-employment subject to self-employment tax.
It is important to note, that a business operated through an LLC which is wholly owned by one individual is treated as a corporation for employment tax and certain excise tax purposes.
C. How the business structure relates to social security status
The classification of a business entity may affect an individual's social security status. For example, if an entity is treated as a corporation for federal tax purposes, a member might receive wages on the same basis as an officer of a corporation. If the entity is instead treated as a partnership for federal tax purposes, the member may receive net earnings from self-employment subject to self-employment tax as a partner.
To determine the status or proper classification of a business entity for social security purposes, make every effort to obtain all of the information and evidence necessary to resolve the issue. The material is general in nature. Some questions will arise that we cannot answer in this section.
D. The entity classification rules
1. The current “check-the-box” regulations
The current IRS entity classification regulations are generally effective January 1, 1997 (hereafter referred to as the check-the-box regulations). The check-the-box regulations provide an elective regime under which any “business entity” that is not a “per se corporation” is an “eligible entity” that may choose its classification. A business entity is any entity recognized for federal tax purposes that is not properly classified as a trust or otherwise subject to special treatment under the Internal Revenue Code. “Per se corporations” are statutory corporations and are not allowed to choose their classification since they must be corporations. “Per se corporations” include state law corporations, insurance companies, and certain banks. Business entities that are not “per se corporations” can elect their classification. An eligible entity with at least two members can be classified as either a partnership or a corporation. An eligible entity with a single member can be classified as either a corporation or disregarded as an entity separate from its owner. An eligible entity may affirmatively elect its classification by filing IRS Form 8832, Entity Classification Election. Please see IRS Form 8832 and its instructions for more information.
2. Prior classification rules
Under the prior IRS regulations in effect prior to January 1, 1997, the IRS classified an entity with associates and an objective to carry on business as a corporation if it had a preponderance of the following factors:
Continuity of life;
Centralization of management;
Limited liability; and
Free transferability of interests.
If it did not have a preponderance of the above factors, the IRS classified the entity as a partnership. The prior IRS regulations generally remain applicable prior to January 1, 1997.
E. References
IRS Publication 3402 Taxation of Limited Liability Companies
Social Security Handbook Chapter 1107 Partnership Defined
Social Security Handbook Chapter 1108 What Factors Indicate a Partnership or Joint Venture
Social Security Handbook Chapter 1110 What Factors Indicate a Valid Partnership