The Commonwealth Court of Pennsylvania held that members of a limited liability company (LLC) are employees of the LLC and are subject to Pennsylvania unemployment tax.

The case, King’s Kountry Korner, LLC v. Dep’t of Labor and Industry, Office of Unemployment Compensation Tax Services, involved King’s Kountry Korner, LLC (Kountry Korner), an LLC that operated two furniture stores in Pennsylvania. Kountry Korner’s managing member owned 90 percent of the company and the other 10 percent was owned by 10 other members, each of whom owned a 1 percent interest. Consistent with both the Internal Revenue Code and Pennsylvania tax law, Kountry Korner filed tax returns as a partnership for tax years 2008 through 2011 and reported amounts paid to the members for working at its stores as sales or delivery persons as “guaranteed payments.”

Generally, under Pennsylvania and federal income tax laws, guaranteed payments include payments for services made to a partner in a partnership or member of an LLC that is treated as a partnership for income tax purposes that are not based on a percentage of the partnership’s or LLC’s profits. Guaranteed payments are not treated as wages for federal or Pennsylvania income tax purposes. Moreover, for both federal and Pennsylvania income tax purposes, neither a partner in a partnership nor a member of an LLC that is treated as a partnership for income tax purposes is treated as an employee of that partnership or LLC.

Nevertheless, the Court observed that the Pennsylvania unemployment compensation law is construed broadly and that once it is determined that an individual has performed services for wages, that individual is presumed to be an employee unless the employer can establish that an exemption applies. The Court dealt in two sentences with the unemployment compensation law, concluding with little explanation that the individuals at issue were employees of Kountry Korner. Specifically, the Court wrote that “[b]ecause the members performed services for wages, the burden shifted to Kountry Korner to establish that they were not subject to its control or direction over their performance and that they were customarily engaged in an independently established trade, occupation, profession or business. As the Department correctly noted, Kountry Korner did not present any evidence to meet its burden.”

Interestingly, the Court also cited two sections of the business corporation law to support its conclusion, both of which apply only to LLCs and not partnerships. One such reference was to a section of the Pennsylvania Business Corporation Law (part of the LLC Act) that was repealed in 1997 that treated LLCs as corporations for Pennsylvania corporate net income tax purposes. The other reference was to a section that provides that a member of an LLC may be an employee or other representative of the LLC and engage in transactions with the LLC, to the same extent as a nonmember.

The decision makes clear that in certain circumstances payments that are not wages for federal or state income tax purposes are subject to Pennsylvania unemployment compensation tax. Any LLC, or perhaps any partnership, in Pennsylvania that makes guaranteed payments to its members for services should evaluate its classification of members or partners, and whether payments to those individuals may be subject to Pennsylvania unemployment compensation tax.

For more information, please contact Tax Group Practice Leader Wendi L. Kotzen at 215.864.8305 or, Labor and Employment Practice Leader David S. Fryman at 215.864.8105 or, Frank A. Chernak at 215.864.8234 or, or the Ballard Spahr attorney with whom you work. 

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