Many tax-exempt organizations have formed single-member limited liability companies (SMLLCs) as integral parts of their entity structure. SMLLCs enjoy flexible treatment for tax purposes, limitation of liability, easy transferability of ownership interest by sale or exchange, and separate governance and management. As a result, they are widely used to conduct various activities and hold investments. However, SMLLCs with employees have new reporting requirements that went into effect Jan. 1.
Some of the important benefits associated with an SMLLC come from its treatment as a disregarded entity for income and employment tax purposes. Absent an election to the contrary, federal tax law treats an SMLLC as a division of its single member rather than as a separate entity. In the context of income tax reporting by a tax-exempt organization, classification as a disregarded entity means that the SMLLC’s revenue, expenditures and activities are attributed to (and reportable by) the single member on Form 990, Return of Organization Exempt From Income Tax.
Formerly, a noncorporate entity with a single owner was disregarded as a separate entity for most federal purposes, including exemption from federal employment tax reporting. Employer organizations had a choice: The disregarded entity’s employment taxes could be paid and reported using the name and employer identification number (EIN) of either the owner or the disregarded entity.
Now the rules have changed. Effective Jan. 1, disregarded entities must separately report for federal employment tax purposes (TD 9356).
The IRS’ stated purposes for the change were: (1) to improve federal tax law administration and simplify federal tax compliance with respect to reporting, payment and collection of employment taxes; and (2) to align federal and state reporting, the latter of which often recognizes a disregarded entity for state employment tax purposes.
WHAT TO DO
Because the new regulations apply to wages paid on or after Jan. 1, exempt organizations and disregarded entities must immediately put systems in place to deal with the administrative burden of calculating, collecting, depositing and reporting employment taxes and wages. Each SMLLC must have its own federal EIN and also enroll in the electronic federal tax payment system (EFTPS).
Exempt organizations and disregarded entities may want to reassess whether employees are employed by the single member or the SMLLC. In addition to ensuring compliance with the new rules, this may require a legal analysis because the decision may affect whether the SMLLC is treated as a separate entity with respect to the limitation of legal liability.
If all employees are employed by the single member (for example, the tax-exempt organization), the practitioner may want to review and formalize the cost-sharing and reimbursement (or management fee) agreement between the single member and the SMLLC.
If the SMLLC has employees, consider whether the employees are able to participate in the owner organization’s retirement plan. To do so, look at the retirement plan documents and see who is technically eligible to participate in the plan. It may be advisable to seek the advice of counsel to help determine whether the SMLLC’s employees technically qualify as participants in the single owner’s retirement plan.
For a detailed discussion of the issues in this area, see “Employment Tax Reporting for Disregarded Entities,” by Mary Torretta, J.D., G. Edgar Adkins Jr., CPA, and D. Greg Goller, CPA, in the March 2009 issue of The Tax Adviser.
—Alistair M. Nevius, editor-in-chief
The Tax Adviser
Also look for articles on the following subjects in the March 2009 issue of The Tax Adviser:
An update on state corporate tax developments.
A discussion of section 121 planning opportunities.
A look at the LIFO conformity requirement under IFRS.
The Tax Adviseris the AICPA’s monthly journal of tax planning, trends and techniques. AICPA members can subscribe to The Tax Adviser for a discounted price of $85 per year. Tax Section members can subscribe for a discounted price of $30 per year. Call 800-513-3037 or e-mail firstname.lastname@example.org for a subscription to the magazine or to become a member of the Tax Section.