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May 31, 2007

Payroll Taxes: The Single Member LLC Owner (Again)

IRS Debts

Houston Tax Attorney

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Many taxpayers do not understand the implications of operating a business as a LLC when it comes to payroll tax liabilities. Apparently even some accounting firms do not fully understand this concept.

The recent McNamee v. Dept. of Treasury case involves a six-person accounting firm that was operated as a single member LLC. The accounting firm failed to pay $64,736.18 in payroll taxes for tax years 2000 and 2001. The LLC ceased operations in March 2002. The IRS disregarded the LLC and imposed tax liens on the sole member’s personal property.

Facts & Procedural History 

The accounting firm owner contested the government’s ability to disregard the entity, arguing that state law prevented the IRS from reaching the owner’s personal assets and that the federal regulations were invalid. The district court and the Second Circuit Court of Appeals rejected the accountants arguments.

Single member LLCs provide very little creditor protection for the owner’s personal assets, especially when the federal government is the creditor and the debt is a payroll tax debt (or possibly when the owner files or is forced into bankruptcy).

The accounting firm in this case could have prevented the IRS from pursuing the owner’s personal assets by simply having a nominal business partner (possibly a having a corporation that was also owned by the sole LLC owner owning a 1% membership interest in the LLC) or possibly by electing to have the LLC treated as a corporation for federal tax purposes.

With that said, the single member LLC might be sufficient to protect the LLC’s assets from the single member owner’s liabilities. An IRS Internal Legal Memorandum prepared by an IRS tax attorney specified that the IRS could not levy on the assets of a single-member LLC to satisfy a tax liability of the LLC’s sole owner solely because the LLC was disregarded for federal tax purposes (See, ILM 199930013, Apr. 18, 1999).

If this is correct, then the interesting question is whether, applying the court’s logic that the payroll tax is a personal liability of the single member LLC owner, the accounting firm could have left the owner’s assets inside of the LLC thereby leaving the assets beyond the reach of the IRS….

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