Both businesses hiring people and people looking for creative ways to structure their jobs may want to know if a corporation can be an employee. The answer is it depends on what you’re trying to do.
Fair Labor Standards Act
The Fair Labor Standards Act is a legal issue not a tax issue. However, many business decisions, like forming a corporation or limited liability company, have both legal and tax considerations.
Courts have ruled that a corporation can be an employee under the Fair Labor Standards Act. In this context, a company was trying to hire its janitors as individual corporations rather than as employees. Each janitor had to create their own company or corporate entity. The court ruled that the economic reality was that except for creating the corporations on paper, the relationship was a traditional employer-employee relationship.
In short, having employees form a corporation to create a business-to-business relationship is not a convenient way to get around the Fair Labor Standards Act by saying someone is not an employee. It also generally won’t change anything for tax purposes.
Benefits of Being a Corporation
Having people working under corporations isn’t always a one-sided move that benefits big companies while hurting workers. There are several benefits of working under a corporation.
- Access to different retirement plan options
- Ability to claim business expense deductions
- Qualifying for the 20% Qualified Business Income deduction
It’s actually common for highly skilled and highly compensated individuals to want to change from being an employee to being a corporation because it will benefit them financially.
Mixing Employees and Contractors
One way to get into trouble with the IRS is to have employees and independent contractors doing the same task. When this happens, it’s difficult to argue that the contractors shouldn’t be reclassified as employees.
The fact that you have an employment relationship with some workers undercuts any idea that your contractors are separate from your company. This includes attempts to distinguish in ways such as temporary vs. permanent or full-time vs. part-time. The IRS primarily looks at the work done and the working relationship.
If you have a single software developer in a retail company, it’s pretty easy to shift them to a corporation if that’s what both sides want. If you have a team of fashion designers who have always been employees, you may not be able to allow one to work as an independent contractor corporation even if they’re the one who wants the change.
Unemployment Benefits and Workers Compensation
Unemployment insurance and workers compensation are often state law issues, but they have similar concerns as the Fair Labor Standards Act. A worker may be able to claim benefits under unemployment or workers compensation even if they are under a corporation by saying they were legally an employee of your company.
Personal Service Corporations
Another thing to keep in mind is that if you’re trying to form a corporation, you may not get the full tax benefits if you’d fall under the rules for a personal service corporation.
A personal service corporation is a C-corporation that
- Performs substantially all of its activities in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, or consulting, and
- Is at least 95% owned by the employees performing the service
Personal service corporations pay taxes at a flat tax rate of 21%. If you file a tax return as a regular corporation, you may get a CP224 Notice to pay additional tax.
If you use an S-corporation, your tax benefits may be limited by the need to tax a reasonable salary. In many cases, if you would be an employee of a business but for the fact that you’re operating under an S-corporation, a reasonable salary would be all or substantially all of what they pay your S-corporation.
Whether you’re a large business doing the hiring or a worker exploring what’s best for you, this is a messy area that depends on the specific facts of the circumstances. Don’t make any kind of move without discussing the issue with your tax and legal advisors.