To overcome getting shorted on the Section 199A deduction or being denied fringe benefits, some sole proprietors and partners instruct their payroll services to make them W-2 employees.
When the payroll services do this, the proprietors and partners believe they are now legitimate employees of their proprietorships and partnerships. Wrong.
The sole proprietor is not a W-2 employee of the proprietorship. He or she is self-employed and operates under the rules for the self-employed.
The partner is not a W-2 employee of the partnership. He or she is a partner and is treated as a partner under the tax rules. Partners receive remuneration for services as guaranteed payments, which are subject to self-employment taxes.
Using a Certified Professional Employer Organization (CPEO) does not create the possibility of paying a W-2 wage to a partner or a sole proprietor.