Understanding Owner-Employee [Internal Revenue]: Key Legal Insights
Definition & Meaning
The term Owner-Employee refers to an individual who holds a significant ownership stake in a business. According to the Internal Revenue Code, this includes proprietors of sole proprietorships and partners in partnerships who own more than 10 percent of either the capital or profits interest. For example, a partner with an 11 percent capital interest, even if they only have a 2 percent profits interest, qualifies as an owner-employee.
Legal Use & context
Owner-employee status is relevant in various legal contexts, particularly in tax law and retirement planning. This designation affects how income is reported and how retirement benefits are structured under plans like 401(k)s. Understanding this term is essential for business owners and partners, especially when navigating tax obligations and retirement contributions.
Real-world examples
Here are a couple of examples of abatement:
Example 1: A partner in a law firm owns 15 percent of the capital and 5 percent of the profits. This partner is classified as an owner-employee due to their capital interest.
Example 2: A sole proprietor of a bakery is considered an owner-employee, as they are the sole owner of the business.
Relevant laws & statutes
The definition of owner-employee is primarily governed by the Internal Revenue Code, specifically:
- 26 CFR 1.401-10(d)
- 26 USCS § 401
- 26 USCS § 707(c)
- 26 USCS § 704(b)