Can a Sole Proprietor LLC put themselves on W-2 payroll?

You're right to be concerned - this is a common misunderstanding with sole proprietorships. In a sole proprietorship (including a single-member LLC that hasn't elected different tax treatment), the owner and the business are legally the same entity for tax purposes. Because of this, the owner can't be their own employee or pay themselves wages. The owner should be taking "owner's draws" instead, which are essentially transfers of profit from the business to the owner. Your husband can absolutely be a W-2 employee since he's not an owner. For your brother-in-law, you'll need to: 1. Stop processing W-2 payroll for him immediately 2. Reclassify his previous "wages" as owner's draws 3. Undo any federal/state withholding and employment taxes paid on his behalf The good news is this is fixable! You'll need to file amended quarterly payroll tax returns (Form 941-X) for any quarters where he received "wages." You'll also need to cancel out his W-2 by issuing a corrected W-2c showing zero wages. Don't panic though - this is a common mistake and your CPA can help straighten it out once she's finished with the other tax issues.

I went through something similar with my landscaping business last year. I had been paying myself W-2 wages as a sole proprietor for almost 2 years before my accountant caught it. I was totally stressed about fixing it, but found this service called taxr.ai (https://taxr.ai) that analyzes your tax situation and explains exactly what needs to be fixed. Their system reviewed my QuickBooks data and previous tax filings, then created a step-by-step correction plan. They explained that as a sole proprietor LLC, I should be taking owner's draws instead of W-2 wages, and showed me how to properly document everything. The report they generated helped my accountant fix everything much faster than starting from scratch. Since you're in almost the exact same situation, it might be worth checking out before going back to your CPA. Saved me a ton of stress and probably money too since my accountant didn't have to spend as much time figuring everything out.

Just wanted to follow up after trying taxr.ai from the recommendation above. I was seriously worried about the mess with my husband's construction business where we'd been doing the same thing - paying him as W-2 when he's a sole proprietor. The report they generated was surprisingly detailed. It flagged exactly which quarters needed amended returns and calculated the approximate refund we should expect from the overpaid payroll taxes. They even created a customized letter explaining the situation that we can give to our accountant. The best part was that it confirmed that my husband's two employees are properly classified as W-2, so we don't have to change anything there. Definitely worth checking out if you're in a similar situation with misclassified owner payments.

Having been through the exact situation you're describing, I know how stressful dealing with the IRS can be. After discovering the mistake with my owner W-2 payments, I spent WEEKS trying to get through to someone at the IRS who could actually help me understand the correction process. Finally found Claimyr (https://claimyr.com) which got me through to an actual IRS agent in under 20 minutes when I'd been trying for days on my own. They have this system that navigates the IRS phone tree and holds your place in line, then calls you when an agent is available. Check out how it works here: https://youtu.be/_kiP6q8DX5c The IRS agent I spoke with was actually super helpful and walked me through exactly what forms I needed for my specific situation. Turns out there are some special procedures for correcting this specific payroll issue that my accountant wasn't even aware of. Saved me a ton of money in potential penalties by getting it handled correctly the first time.

I need to eat my words from my skeptical comment above. After weeks of failing to get through to the IRS on my own about a similar sole proprietor payroll issue, I broke down and tried Claimyr. Got connected to an IRS agent in about 35 minutes (they said the wait would be around 45, so actually faster than estimated). The agent confirmed that as a sole proprietor LLC, my brother shouldn't have been on payroll, but also gave me the exact procedure for correcting it without penalties since it was an honest mistake. They walked me through how to properly document owner's draws going forward and explained how the Schedule C reporting works instead of W-2. Most importantly, they flagged that we need to be making quarterly estimated tax payments since there's no withholding on owner's draws. Seriously impressed with being able to actually talk to someone at the IRS after failing for so long on my own.

Another important thing to consider - if your brother-in-law has been a sole proprietor taking W-2 wages, he's likely been underpaying self-employment tax. As a sole prop, he owes SE tax on ALL business profits, not just what he took as salary. Make sure when you fix this that you're accounting for the 15.3% self-employment tax on the business profits. Many sole proprietors get shocked by this when they switch from W-2 to proper owner's draws. Also, has he been making estimated quarterly tax payments? If not, there might be underpayment penalties to deal with too.

Something nobody's mentioned - your brother-in-law should seriously consider changing his LLC to be taxed as an S-Corporation instead of a sole proprietorship. That would actually allow him to legally pay himself a W-2 salary AND potentially save on self-employment taxes. With an S-Corp election, he could pay himself a "reasonable salary" on W-2 (which is subject to FICA taxes) and then take additional distributions that aren't subject to self-employment tax. Could save thousands depending on the business profits.

This is such a common mistake - you're definitely not alone in dealing with this! I made the exact same error with my cleaning service LLC for about 8 months before my bookkeeper caught it. The good news is that this is totally fixable, and the IRS generally treats it as an honest mistake when sole proprietors accidentally put themselves on payroll. Here's what worked for me: 1. **Stop the payroll immediately** - No more W-2 processing for your brother-in-law starting now 2. **Document everything** - Keep records of all the incorrect W-2 payments to make the correction process smoother 3. **Don't panic about timing** - Yes, you'll need to file amended returns, but you have time to do this properly One thing I learned is that it's actually better to fix this sooner rather than later. The longer you wait, the more quarters you'll have to amend, and it becomes more complicated. Since your CPA is already swamped with previous years' issues, you might want to gather all the payroll documentation first so when you do bring it to her, she has everything she needs to fix it efficiently. This will save both time and money. Also, make sure you understand the difference between owner's draws and distributions going forward - it'll prevent this from happening again once everything is corrected.

I really appreciate everyone sharing their experiences here - it's reassuring to know this isn't an uncommon mistake! Based on what I'm reading, it sounds like while this is definitely something that needs to be fixed, it's not the end-of-the-world catastrophe I was worried it might be. A few follow-up questions as I'm processing all this great advice: 1. Should I stop my brother-in-law's payroll immediately (like this week) or wait until we have a correction plan in place? I don't want to create more complications by stopping mid-quarter. 2. For the amended returns, does anyone know roughly how long the IRS typically takes to process the refunds for overpaid payroll taxes? We could really use that money back to help with cash flow. 3. The S-Corp election option sounds interesting for the future, but given that we're already dealing with missing 2023 returns and other tax issues, I'm thinking we should probably get everything cleaned up first before making any major tax structure changes. Does that make sense? Thanks again to everyone who's taken the time to share their knowledge and experiences. This community has been incredibly helpful during what's been a pretty stressful situation!