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Employment Tax Obligations of Single Member LLCs

Most Single Member LLCs either elect or are by default classified as disregarded entities for Federal income tax purposes. Recent Treasury Regulations change this result for Federal employment tax purposes. Treas. Reg. Section 301.7701-2(c); TD 9356, 207-39 I.R.B. 675. Effective January 1, 2009, limited liability companies that are disregarded for all other purposes will be treated as corporations for Federal employment tax purposes. Id.

Generally, characterization of an otherwise disregarded entity as a corporation for Federal employment tax purposes is positive for taxpayers. Instead of having personal liability for unpaid employment taxes, the owner of the LLC will only be liable for payroll taxes attributable to employees of the LLC if the requirements of Code Section 6672 are satisfied for imposition of the 100% Trust Fund Recovery Penalty. See IRC Section 6672; In re Macagone, 253 B.R. 99 (M.D. FL 2000); Thomsen v. United States, 887 F.2d 12 (1st Cir. 1989). Even assuming that in most circumstances the owner of a single member LLC will be fully liable as a result of imposition of the 100% penalty for the trust fund (employee) portion of the withholding tax, liability for the employer portion would be rare and require a determination that it is appropriate to ?pierce the corporate veil.? See Stramaglia v. U.S., 2007 WL 4404185 (E.D. Mich. 2007). This does, however, create some importance to applying entity formalities so as to create some separation between the LLC and its owner by giving a separate identity to the limited liability company. SeeBart Arconti & Sons, Inc. v. Ames-Ennis, Inc., 275 Md. 295, 309-310 (1974).

The new regulations are a rather dramatic change of position for the government from the position taken in cases such as Acme v. Department of Treasury, 488 F.3d 100 (2nd Cir. 2007). In Acme, the government maintained and the Second Circuit agreed that the owner of a single member LLC otherwise disregarded for tax purposes was personally liable for the limited liability company?s employment tax deficiencies. Id. at 104-105.

While generally positive for owners of single member LLCs, the new Regulations are not without their difficulties. First, some states (such as Minnesota and Wisconsin) require that state unemployment taxes and in some cases employer income taxes be assessed against the owner of a single member LLC and not the entity. See e.g., Minn. Stat. § 268.063; Wis. Stat. Ann. § 108.22(9).California allows single member LLCs to elect whether to be disregarded for state income tax purposes or treated as corporations. Cal. Rev. & Tax. Code § 23038(b)(2)(B)(i). However, the California State Franchise Tax Board may require employment taxes to be assessed against the owner regardless of the election. Cal. Unemp. Ins. Code §§ 1731?1736. Statutes in North Carolina permit similar discretion by the state tax authorities. N.C. Gen. Stat. Ann. § 96-10(d). Second, the new Regulations create administrative problems for single member LLCs classified as disregarded entities. Rather than being treated uniformly for all taxes, the new Regulations require that a single member LLC be treated as a disregarded entity for all taxes except Federal employment taxes. Treas. Reg. Section 301.701-2(c). Finally, in states which continue to view the owner as liable for state unemployment and withholding taxes, employment tax filings for state and Federal purposes will be inconsistent.

In those states which permit election, there may be advantages to treating an LLC as the employer for state payroll taxes as well as Federal taxes. New employers often have an unemployment tax rate lower than the unemployment tax rate for established businesses with histories of layoffs (particularly in changing economic times). See e.g., Va. Code Ann. § 60.2-530. So long as the newly formed LLC can avoid state laws enacting the SUTA Dumping Prevention Act of 2004, the ability to treat the LLC as the employer may allow more favorable rates of withholding for state unemployment tax purposes. 42 U.S.C. §503(k)(l)(A). The SUTA Dumping Prevention Act of 2004 prohibits the Secretary of Labor from certifying grants to a state if the state has not enacted laws prohibiting businesses from forming new successor entities solely for the purpose of clearing prior negative unemployment experience. Under the requirements of the Act, if a business has the same or substantially common ownership, management, or control, the unemployment experience of the old entity is transferred to the new entity. 42 U.S.C. §503(k)(l)(A).

ChisholmOliver, LLP represents taxpayers in a variety of tax controversy matters including unpaid withholding taxes. If you have questions regarding the new Treasury Regulations under IRC §7701 or wish to discuss some of the issues created by those Regulations as they relate to your clients, please feel free to contact me at any time.