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PILLA TALKS TAXES

Dan’s newsletter Pilla Talks Taxes is published ten times per year with articles designed to help you stay current on new laws, strategies and defenses. Dan will show you how to protect and defend your clients' rights, new ways to cut taxes and how to avoid problems with the IRS. If it is important for you to know, you will find it in this newsletter! You'll be among the first to know what's going to happen, even before it happens, making you invaluable to your clients.

Pilla Talks Taxes is a must-have for any tax professional. Subscriptions are available direct from WINNING Publications, Inc. for $99/year, however TFI Members receive a free subscription as part of their membership benefits. In addition, our members are able to access a searchable archive of past Pilla Talks Taxes articles. Below is a example of the no-nonsense information you will find in Dan's newsletters.

Featured Article

TAX LEVIES AND LLC's - Can the IRS Reach an LLC's Assets?

July 2011, Pilla Talks Taxes

Limited Liability Companies (LLC) are all the rage as far as new business operating structures are concerned. They’ve been around for many years but recently have found favor with lawyers and tax planners alike when it comes to creating an entity under which to operate a new business.

LLCs have many advantages that make them attractive, including the fact that just one person can be a member of an LLC, thus controlling the entity without interference from a board. For more details on the tax treatment of various entities, including LLCs, see my report entitled, "DAN PILLA’S GUIDE TO STARTING YOUR OWN BUSINESS: Considerations for a Business Structure and Operation," January 2011, Pilla Talks Taxes.

For federal tax purposes, LLCs are disregarded entities. That means that they do not enjoy their own unique tax treatment or consideration for federal income tax purposes. The manner in which an LLC is taxed depends entirely upon how it is structured and whether the founding member of the LLC makes an election to have it treated in a particular way for tax purposes. 

For example, a single member LLC can be treated as either a corporation or a sole proprietorship. If the single member does not make an election, the LLC is by default treated as a sole proprietorship. A multimember LLC can be treated as either a partnership or a corporation. If no election is made, by default, the multimember LLC is considered a partnership. See Revenue Regulation section 301.7701-3(b).

This begs the question, if the LLC structure is “disregarded,” why bother to set it up in the first place? Understand that the term “disregarded” applies only to the manner in which the entity is treated for federal income tax purposes. Since LLCs became a creature of state law and have fallen into favor with tax planners, Congress has not seen fit to amend the tax laws to expressly provide for the manner in which they are to be taxed. By contrast, the tax code spends hundreds of pages addressing how corporations, partnerships, trusts and sole proprietorships are to be taxed.

The question of how LLCs are to be taxed was therefore made a matter of regulation. LLCs are given the option to simply elect how they are to be treated for tax purposes. The IRS must live with that election.

So what happens to an LLC if a member owes federal income taxes? If the LLC is disregarded for tax purpose, can the IRS reach through the LLC veil and seize the assets of the company to pay the debts of the member? This has become a concern as the IRS gets more aggressive with the collection of debts.

To set up the answer, let’s first compare this to a corporation. A corporation is a separate legal entity under state law. The corporation’s officers or employees do not own the corporation’s assets. In fact, not even the shareholders own the corporation’s assets. Shareholders merely own a percentage share of the corporation’s profits, measured by their share of the stock, should the corporation decide to distribute profits. But no shareholder has the right to waltz into the offices of a corporation, present his stock certificates to the secretary and walk out with his share of the office furniture.

Likewise, if a shareholder of, say IBM, owes money to the IRS, the IRS cannot seize any of the corporation’s income or assets to satisfy that debt. The IRS can seize the shareholder’s stock and sell it. Also, the IRS can stand in the shareholder’s shoes vis-à-vis his right to a share of IBM’s profit distribution. Say for example IBM declares that it will distribute fifty cents per share to each of its shareholders. Suppose a delinquent citizen owns one hundred shares of IBM stock. In that case, IBM owes the shareholder $50. The IRS can issue a levy to IBM for the $50 owed to the shareholder, thus seizing that dividend payment. That is the extent to which the IRS can mess with IBM.

Now let’s apply this to an LLC. Is the answer the same? The IRS sometimes argues that if it’s dealing with a single member LLC, and the single member owes taxes, the IRS can seize the assets of the LLC because it’s a disregarded entity and there’s just one owner. That is, the IRS just looks past LLC status.

But this conclusion is dead wrong, even for a single member LLC. Keep mind that the LLC is disregarded only for the purposes of determining the entity’s (not the members’) tax status. When it comes to the ownership issue, the IRS must look to state law to determine whether a person has an ownership interest in any particular asset. Aquilino v. United States, 363 U.S. 509 (Sup. Ct. 1960). If state law does not vest an ownership interest in an asset in favor of the person who owes the tax, the IRS cannot seize that asset—period. 

Based on this settled legal principle, the question is, does state law create an ownership interest in favor of a member in the assets of an LLC? This question has to be answered on a state-by-state basis. However, generally speaking, the answer is no. That’s the very idea behind an LLC. The structure is by definition a separate legal entity capable of owning its own assets, just like a corporation. The LLC’s assets are not commingled with those if its members. If that were not true, there’d be no point to an LLC whatsoever.

Just as in the case of IBM, a levy might be made for distributions by the LLC that are based on the single member’s interest in the LLC. Say the single member supports himself from the net income of the LLC. The IRS can issue a levy notice to the LLC to intercept the distributions of that income. In this regard, the IRS stands in the shoes of the single member, executing his right to receive the distributions, just as in our IBM example above. See, United States v. Moskowitz, Passman & Edelman, 603 F.3d 162 (2d. Cir. 2010)(frequent and regular partnership “draws” which are advances or loans on annual profits are subject to a lien any may be levied as salary or wages). See IRS Chief Counsel Advice Memo 201116019, April 25, 2011.

Another problem with single member LLCs presents itself in collection cases. That is the question of whether the LLC is really just the alter ego of the single member. An entity is an alter ego if the economic realities of the situation make the two (the individual and the entity) indistinguishable. In other words, the entity simply functions as the “left pocket” of the individual. In that case, the IRS could pierce the LLC veil and reach the assets.

However, the question of whether the LLC veil can be pierced is also largely an issue controlled by state law. There has been substantial law created in this area over the years as the IRS has been highly successful in piercing trusts and corporations for tax collection purpose under the right circumstances.

One of the topics we  covered at the 2011 Taxpayers Defense Conference is the alter ego issue. This is very important as more citizens use entities of various kinds to protect their personal assets, not only from potential business-related litigation, but from the IRS as well. 

Found in July 2011 issue Pilla Talks Taxes

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Featured Article

LEVY OF SOCIAL SECURITY BENEFITS 
IRS To Limit How Much It Will Seize

A common question with delinquent citizens is whether the IRS can levy social security benefits. The answer, unfortunately, is yes they can, and worse, they do so regularly. Before intercepting an SS payment, the IRS generally sends notice CP91, Final Notice Before Levy On Social Security Benefits. This letter informs you of the impending levy and invites you to call the IRS to set up payments if you cannot pay in full. 

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