Can I Be a W2 Employee of My Own Company?

Many entrepreneurs and new business owners eventually ask a fundamental question: Can I be a formal W-2 employee of my own company? The idea of receiving a regular paycheck with tax withholdings is a common goal as a company grows. Understanding the possibilities and limitations is a function of how the business is legally organized.

Business Structure and Employee Status

The ability for a business owner to be classified as a W-2 employee is determined entirely by the company’s legal structure. For sole proprietorships and general partnerships, the owner cannot be an employee. In these structures, there is no legal distinction between the owner and the business, meaning the owner is considered self-employed and takes money from the business through an owner’s draw.

Limited Liability Companies (LLCs) have specific default rules. By default, a single-member LLC is taxed like a sole proprietorship, and a multi-member LLC is taxed like a partnership. Under this default tax treatment, the LLC members are not considered employees and cannot receive a W-2 salary, instead taking draws or guaranteed payments.

The situation changes when a business is structured as a corporation or when an LLC elects to be taxed as one. Both S Corporations and C Corporations are legal entities separate from their owners, which permits an owner who actively works in the business to be classified as an employee. For S Corporations, it is an IRS requirement that shareholder-employees who provide services be paid a reasonable salary before receiving other payments, known as distributions.

An LLC can file an election to be taxed as an S Corporation or a C Corporation. Once this election is made, the LLC owner who performs services for the company can be placed on the payroll.

Determining Reasonable Compensation

Once an owner can be an employee, the company must determine an appropriate salary. The Internal Revenue Service requires that owner-employees of corporations be paid “reasonable compensation” for the services they provide. This standard means the salary should reflect what a similar business would pay for comparable services, preventing owners from disguising salary as corporate distributions to avoid payroll taxes, an issue particularly scrutinized in S Corporations.

The IRS does not provide a specific formula for calculating a reasonable salary; the determination is based on a collection of facts and circumstances. Key factors considered include:

• The owner’s training and experience
• Their specific duties and responsibilities
• The amount of time and effort dedicated to the business
• The company’s dividend history
• Compensation paid to non-shareholder employees
• What comparable businesses pay for similar services

To establish a defensible salary, a business owner should document the basis for the compensation amount. This could involve researching salary data from sources like the Bureau of Labor Statistics or obtaining a formal compensation analysis. Arbitrary methods, such as setting salary as a fixed percentage of profits, are not endorsed by the IRS and may not hold up under examination.

Payroll and Tax Withholding Obligations

Establishing a salary for an owner-employee initiates formal payroll and tax duties for the company. The business must act as an employer, withholding federal income tax and the employee’s share of Federal Insurance Contributions Act (FICA) taxes. FICA is composed of two separate taxes: Social Security and Medicare.

For 2025, the employee’s Social Security tax is 6.2% on wages up to the annual wage base limit of $176,100. The Medicare tax is 1.45% on all wages with no income limit. The employer must match these FICA contributions, paying an additional 6.2% for Social Security and 1.45% for Medicare.

The company is also responsible for paying Federal Unemployment Tax (FUTA) and State Unemployment Tax (SUTA). The standard FUTA tax rate is 6.0% on the first $7,000 of an employee’s wages. However, employers can receive a credit of up to 5.4% for timely SUTA payments, reducing the effective FUTA rate to 0.6%.

These payroll activities require regular tax filings, with employers reporting and paying these taxes quarterly. Annually, the company must file a return for federal unemployment taxes. For each calendar year, the business must provide the owner-employee with a Form W-2, summarizing their total wages and tax withholdings.

Implications for Retirement and Health Plans

Classifying an owner as a W-2 employee has direct consequences for their ability to participate in company-sponsored benefit plans. Being on the payroll allows the owner to contribute to retirement plans like a 401(k) as an employee. This differs from plans available to the self-employed, such as a SEP IRA, which have their own distinct contribution rules.

The treatment of health insurance premiums is also affected. For an owner of an S Corporation who holds more than a 2% share, the corporation can pay for health insurance premiums. These premiums are then reported as taxable wages on the owner’s Form W-2 for income tax purposes, but they are not subject to FICA or FUTA taxes. The owner-employee may then be able to take a self-employed health insurance deduction on their personal income tax return.