LLC Owner Liable for Employment Taxes

Sean was the sole owner of an accounting firm that was set up as a limited liability company (LLC) under state law. When the firm went out of business, it had not paid any payroll taxes for the preceding 18 months. Perhaps thinking that an accounting business, of all things, should have stayed current in its payment of payroll taxes, the IRS went after Sean personally for the $65,000 in unpaid taxes. A federal court upheld a judgment against him.

The authority of the government to look to the business owner in his personal capacity for satisfaction of the tax liability went back to the formation of the business. Treasury Regulations allow an individual who is the only owner of an LLC to elect to have the business classified as either an “association” or a “sole proprietorship.” In the former situation, the entity is treated like a corporation. In the latter case, which had been selected by Sean, the business is not considered an entity separate from the owner.

Sean challenged the tax assessment against him, but to no avail. The court rejected his argument that the Regulation imposing liability on him as an individual was invalid because the legislation itself, the Internal Revenue Code, does not expressly authorize imposing personal liability on the sole owner of an LLC. The Regulations, like many others issued by the Treasury Department, are intended as a means to “fill in the gaps” left by the Internal Revenue Code.

Notwithstanding the ultimately onerous effect on Sean of his earlier selection under the Regulations, they are not arbitrary, capricious, or unreasonable. When he checked the box on a form choosing treatment of his company as a sole proprietorship, he effectively agreed to be liable for the company’s debts, but he also had benefited by avoiding the double taxation–once at the corporate level and once as an individual shareholder–that comes with treatment as a corporation.