Can LLC Use Crewman’s Exemption for Employment Taxes?

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Raising A Tax Issue For The First Time In Court
Raising A Tax Issue For The First Time In Court

This is a question about international tax laws. Can a U.S. citizen who owns and operates a vessel outside of the U.S. avoid paying U.S. employment taxes for its crewmen by using a foreign legal entity? The court considered this issue in DAF Charters LLC v. Commissioner, 152 T.C. 14, for a single-member LLC formed in the U.S. that was owned by a foreign blocker entity.

Facts & Procedural History

The taxpayer is a Florida limited liability company that is solely owned by a Cayman entity. The Cayman entity has one owner who is a U.S. citizen.

The taxpayer operated a charter boat that traveled in and out of the U.S. and its territorial waters.

The boat was registered in the Cayman Islands. The crew consisted of U.S. citizens.

The taxpayer filed employment tax returns claiming that the crew members were exempt from U.S. employment tax.

The IRS adjusted the taxpayer’s account and litigation ensued. The question for the court is whether the crewman’s exception to employment tax applies.

About Employment Taxes & The Crewman’s Exemption

It is hard for many small businesses to keep up with and pay employment taxes. This is particularly true for small businesses that employ a significant number of workers.

The employment taxes are imposed on the employer and the employee. The employer is tasked with withholding these amounts and remitting them to the IRS each quarter.

This applies to any service provided in the U.S. and to services provided on a U.S. vessel while the vessel touches at a port in the U.S. But what about services provided outside of the U.S.? This is where the crewman’s exemption comes in.

The crewman’s exemption says that services provided outside of the U.S. by a U.S. citizen are only subject to U.S. employment tax if the worker is an employee for an “American employer.”

Who is an “American employer?” The Code defines the term to include an employer which is:

  1. the United States or any instrumentality thereof,
  2. an individual who is a resident of the United States,
  3. a partnership, if two-thirds or more of the partners are residents of the United States,
  4. a trust, if all of the trustees are residents of the United States, or
  5. a corporation organized under the laws of the United States or of any State.

For the last item, what counts as a “corporation?” Is a limited liability company a corporation? The DAF Charters case provides the U.S. Tax Court’s answer.

A U.S. LLC is an American Employer

According to the court, a corporation, for purposes of who is an “American employer,” looks solely to where the entity is formed. The entity in this case was formed in Florida. Thus, according to the court, the Florida LLC is an American employer for employment tax purposes.

The court reached this decision even though the Florida company in question is an LLC. An LLC is clearly not a corporation under state law. The two are authorized by different statutes and have many different features.

One notable difference is the Federal income tax treatment. Given the check-the-box regulations, an LLC with a single owner is a disregarded entity if it has not elected to be taxed as a corporation, partnership, etc. The result is that an LLC is not subject to income tax in the U.S.

The court noted that being a disregarded entity for income tax does not equate to being a disregarded entity for employment taxes. This rule was changed in 2009, making disregarded entities such as LLCs–not their owners–liable for employment taxes. It was this change that the court in the present case relied on to find that the LLC is a corporation for the crewman’s exemption.

Given the court’s decision, in this case, those operating vessels outside of the U.S. may need to evaluate whether they are subject to employment tax in the U.S. It may be advisable to make additional changes to the legal ownership structure to avoid triggering U.S. employment taxes.

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