IRS Collection of Employment Taxes from Partnership-Type Organizations
An Article by WILLIAM A. TAYLOR (The Business Lawyer)
Now that the movie “Fahrenheit 9/11” has been released, I can allow current politics to be discussed by more capable people and can stop my political ranting in this column – in order to get back to business and tax law. However, my appreciation must first be publicly expressed to Dr. Diane Howell, the publisher, who allowed me to vent when the absurdities of the current political environment began to constrict my thinking.
IRS Tax Collection from Partners The power of the IRS to collect employment taxes from the multiple owners of a non-corporate business – is the subject of this article.
A key word is “multiple.” That word rules out a discussion of sole proprietorships – one person or a husband and wife owning a business. With sole proprietorships, the owners are the business; the IRS can collect. How about single member limited liability companies (LLCs)? More on that later.
A business owned by more than one person is now considered to be a separate thing, removed from its owners for corporate and tax purposes – – “sometimes.” It is the “sometimes” that we will explore.
Hypothetical Two people form a joint venture (defined as a general partnership that is limited to an agreed-upon single project or business). The payroll taxes of their six or sixty employees have not been paid to the government as required. Question: Who (the joint venture business or the owner partners) is liable for those unpaid payroll taxes?
Recent U.S. Supreme Court Position on the Hypothetical – General Partnerships A recent case resulted in the U.S. Supreme Court holding that although a) the “taxpayer” is the general partnership (the joint venture in the Hypothetical) and b) the “taxpayer” is not the individual partners, c) no notice needs to be given to the individual general partners in order to collect the partnership’s taxes against them personally.
It held that the taxpayer is the “employer” that is responsible for employment taxes and that state law is to be used to determine if partners and their partnership are two separate groups or are one and the same. In this case, state law considered them separate and the U.S. Supreme Court followed that state law (California). However, and in spite of the logic followed by the justices, the Clarence Thomas opinion still held that the general partners did not need to have received the notice, that was served on the partnership three years earlier, and that collection against the general partners was proper.
This U.S. Supreme Court case (United States v. Galletti) is an exceptional case; it dealt with very narrow issues of 3 year versus 10 year collection periods surrounding assessments and notice requirements. Unlucky lawyering allowed for the result against the partners.
You general partners out there should take notice: Unless you form and operate in an LLC or a corporation, you will be immediately held personally liable for your partnership’s unpaid payroll taxes – without personal assessments by the IRS. Because corporations are automatically considered separate for the individuals owning and operating them, corporate officers must be first assessed by the IRS to have a determination made if they are or are not a “responsible officer” (who has the power to pay employment taxes or pay a supplier). That two step “shield” helps eliminate the immediacy of liability for unpaid taxes of the organization.
The logic of that U.S. Supreme Court case notwithstanding, you can still be held liable for unpaid employment taxes, in any case. The court held that it would follow state law. Under state law, you general partners and joint venturers are personally liable for the obligations of the partnership. The IRS will be able to hold you to be personally liable for the employment taxes of the partnership.
Recent IRS Position on the Hypothetical – LLCs A recent IRS Revenue Ruling (2004-41) concerns limited liability companies (LLCs). In that ruling, the IRS also defers to state law in the matter of members (owners) of an LLC being considered separate from the LLC in regards to LLC members being held liable for LLC employment taxes and other debts and obligations. California state law holds that an LLC that has several members is separate from its members (its owners) in the matter of liability for debts and obligations.
The owners of a multi-member LLC can come in two stripes: one is an owner who is participating in management; the other type of owner is classified as merely an investor – who does not participate in management. Those members who are merely investors in the LLC are covered by this revenue ruling and can expect to be immune from IRS collection activities. The “manager” members, however, will be treated as though they were general partners of a general partnership (see above); employment tax collection against them is possible because general partners are liable for debts and obligations of a general partnership under state law.
Single Member LLC Likewise, the owner of a single member LLC is likely to be held responsible for the LLC’s employment taxes, in spite of California law holding the LLC to be separate from the owner. The reason is that most single member LLCs are managed by the single member, who has the power to pay employment taxes or pay a supplier.
However, it need not be that the single member LLC is managed by the single member. A professional manager may be hired. For those who are the only owners of an LLC but who have hired someone to manage its day-to-day activities, the Revenue Ruling should apply to exempt them as well.
Again, you general partners should take notice: Unless you form and operate your business in an LLC or a corporation, you will be immediately held personally liable for your partnership’s unpaid payroll taxes.
ABOUT THE AUTHOR: William A. Taylor, attorney at law, does business as “THE BUSINESS LAWYERS.” He can be reached at (510) 893-9465