Workers may be classified as employees rather than partners depending on the legal entity the co-op decides to form under. LLCs, Partnerships, and Cooperative Corporations each have different implications regarding worker classification and therefore it is important to talk to a lawyer about your specific business.
Worker Classification for Cooperative Corporations, LLCs, and Partnerships
Cooperative Corporations
In some jurisdictions and under some statutes, courts have leaned toward the assumption that shareholders of corporations should be treated as employees when they work for the corporation they co-own. In other jurisdictions, the fact of incorporation is merely one factor, among many, that a court would consider in determining whether an employment relationship exists. Generally, corporations are required to treat their officers as employees for tax purposes, but this does not automatically extend to wage and hour law, workers’ compensation, and other areas of employment law. For worker cooperatives, the determination of whether members are considered employees or partners can significantly affect their treatment under various laws. In California, worker cooperative members often don’t feel like they are employees, especially in the early stages of a startup. However, for legal and regulatory purposes, they might need to provide themselves with employee protections from day one. This includes adherence to minimum wage laws, workers’ compensation insurance, and paid sick leave.
LLCs and Partnerships
The choice between forming as a cooperative corporation versus an LLC or another entity can have substantial implications. For instance, workers for corporations are presumed to be employees under California law, whereas managing members of LLCs are not, assuming they share in the ownership and control of the business. Uncertainty about whether incorporation automatically creates an employment relationship has caused stress for some worker cooperatives, which are often formed as some type of Cooperative Corporation. As a result, some worker cooperatives have chosen instead to form partnerships or limited liability companies (LLCs), entities where a court is less likely to find that managing partners and managing members are employees. However, employment laws are still applicable when an LLC or a partnership elects to be taxed as an S corporation and pays salaries to its managing partners or members. This is because, in such scenarios, the business is treating these individuals as employees for the purpose of payroll taxes. The S corporation status allows for the separation of salary and dividend distributions, potentially offering tax advantages. Still, it requires the payment of a reasonable salary to shareholder-employees, which subjects those payments to employment taxes.
Legal Entity is Not the Only Consideration
Classification is not black and white. Many factors are taken into consideration, not only the legal entity. There have been court rulings that found that a “partnership,” rather than employment, relationship exists even when the entity is a corporation. Many courts may ultimately consider the incorporation status of an entity as relevant, but only as one factor among many in determining whether an employment relationship exists.
The lesson here is: If you are planning to form a cooperative corporation, as opposed to a partnership or LLC, be extra attentive to the question of whether there is an employment relationship, and talk to a lawyer.
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