Thursday, May 31, 2007

INTERESTING DISREGARDED ENTITY CASE

A recent tax case involving a disregarded entity was interesting to read – not so much for the result but for the business of the taxpayer.

First, about the case. The taxpayer in the case was the sole member of a Connecticut limited liability company. As a single member LLC, the LLC was "disregarded" for federal tax purposes. As such, its individual member was required to report on its own tax return the tax income and expenses.

The LLC did not pay its federal payroll taxes. Due to that failure, the IRS assessed those taxes against the sole member since the LLC was a disregarded entity. The owner claimed he was not responsible for the LLC payroll tax obligations based on provisions of Connecticut law that a member of an LLC is not responsible for the obligations of the LLC.

The 2nd District Court of Appeals predictably held that the member was responsible for the taxes. The Court noted that the member "could have had the benefit of limited personal liability if he had simply elected to have his LLC treated as a corporation; he chose not to do so and thereby avoided having the LLC taxed as a separate entity. We know of no provision, policy, or principle that required the federal government to allow him both to escape personal liability for the taxes owed by his sole proprietorship and to have the proprietorship escape taxation as a separate entity." The Court also noted that courts have already recognized other areas of tax law where tax obligations of an entity may be imposed on an owner notwithstanding limitation of liability provided under State law.

So what was interesting about the business of the taxpayer? It was an accounting firm – probably the last people you would expect to believe that a member could have disregarded status for computation and payment of some federal taxes while having no personal liability for other federal taxes of the entity.

McNamee v. Dept of Treasury, 2007 U.S. App. LEXIS 12016 (2nd Cir. 2007).

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