When trying to settle a tax debt with the IRS or manage the collection process, there are often questions as to whether the IRS can collect from a legal entity owned by the taxpayer. This often comes up in the context of a limited liability company that has one owner. You may be surprised to learn that despite its broad administrative collection powers, some assets held by single-member LLCs may be beyond the IRS’s reach.
Disregarded Entities, Generally
Taxpayers can chose to operate using a legal entity. The legal entities may include corporations, limited liability companies, and partnerships and certain limited liability partnerships.
Legal entities are formed under and governed by state law. State law generally limits the business owner’s liability for the business’s debts. As discussed in this article, this may or may not include Federal taxes.
Taxpayers also have a choice as to how their legal entity will be taxed, including corporations, limited liability companies (LLCs), and partnerships. The type of entity dictates how Federal income taxes are assessed and, ultimately, who is liable for the tax and subject to the IRS collection powers.
Corporations, S corporations, and partnerships are generally treated as separate entities for Federal income tax purposes; whereas, single member LLCs (and some LLCs owned by a husband and wife as outlined in Rev. Proc. 2002-69, 2002-2 C.B. 831) are disregarded for Federal income tax purposes. See Treas. Reg. § 301.7701-1(a)(4).
This disregarded aspect of LLCs adds a layer of complexity when it comes to the IRS’s ability to collect Federal taxes.
Single-Member LLCs and Federal Income Taxes
As noted above, a single-member LLC is disregarded for Federal income tax purposes. This means that the LLC’s profits (and losses) are used to compute the LLC owner’s Federal income tax liability. This disregarded aspect only applies to the computation of tax and how the tax is recorded in the IRS’s books. It does not mean that the LLC is disregarded for purposes of collecting Federal income taxes owed by the LLC owner.
The IRS generally cannot levy on the LLC’s assets to satisfy the LLC owner’s liabilities. You can find an example of this in See CCA 200235023, in which the IRS concluded that only the owner’s assets, and not the LLC’s assets, can be pursued in collection of the tax.
Moreover, the LLC’s assets are not counted in determining the “reasonable collection potential” under the IRS collection guidelines. The IRS has to afford collection rights to the LLC owner, not the LLC. For example, in CCA 200216028, the IRS concluded that it had to issue another collection due process notice as the original notice was only sent in the name of the LLC, not the LLC owner.
When the taxpayer attempts to resolve the Federal income tax arising from the profits of a single-member LLC, the taxpayer has to do so under their personal account. For example, if the taxpayer is submitting an offer in compromise to settle the tax debt for less than the amount owed, the offer has to be made by the LLC owner personally. The rules can be different for Federal employment and excise taxes.
Single-Member LLC’s and Employment and Excise Taxes
The IRS’s ability to collect employment and excise taxes is more complicated. The general rule is that the IRS can only collect these taxes from the LLC’s assets. As a result, an IRS lien will only attach to the LLC’s assets. It will not attach to the LLC’s owner’s assets. This also means that the LLC is the party that must submit an offer in compromise to settle employment and excise taxes, not the LLC owner.
These rules are different for excise taxes that arose in or before 2007 or employment taxes after 2008 (effective for tax periods after January 1, 2008 for excise taxes and for tax periods after January 1, 2009 for employment taxes, see Reg. § 301.7701-2). Prior to the the law changing in 2007, the IRS could only collect from the LLC’s owner’s assets, not from the LLC’s assets. This is true even if the tax was reported and assessed under the LLC’s name and using its employer identification number [The IRS also takes the position that the LLC owner’s name can be added to the assessment without triggering a requirement that a new statutory notice be issued to the LLC owner. This issue has not been litigated as of the date of this article. See CCA 200235023.]
Other Collection Alternatives
If the IRS is not able to collect from the LLC’s assets using its administrative collection powers, it may be able to use the courts to do so. This typically involves the IRS bringing suit against the LLC as an alter ego or nominee of the LLC owner or based on transferee liability for assets transferred to the LLC. With employment taxes, the IRS may also pursue trust fund recovery penalties against the LLC owner to effectively transfer the employee-withholding portion of this tax to the LLC owner’s personal account.
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