LLC’s sole member is held liable for employment taxes

An LLC is treated by default as a disregarded entity, the Tax Court holds.
By Maria M. Pirrone, CPA, LL.M., and Joseph Trainor, CPA, Ph.D.

The Tax Court held that a sole member of an LLC was liable for the company's employment tax liabilities because the LLC was treated as a disregarded entity in the absence of an election to be treated as a corporation.

Facts: In 1989, Heber Costello incorporated Heber E. Costello Inc. (HECI) and was the sole owner of the corporation. HECI filed Form 1120, U.S. Corporation Income Tax Return, for each of its tax years. Costello died and his son, Scott Costello, became the sole owner of HECI. In 2003, Scott Costello formed Heber E. Costello LLC, with himself as the sole member. HECI and the LLC merged, and HECI ceased to exist. The LLC never filed Form 8832, Entity Classification Election. After the merger, the LLC filed Forms 1120 each year using HECI's employer identification number.

The LLC did not make sufficient tax deposits or pay the tax due for the first three quarters of tax years 2007 and 2008 or pay the tax due for its employment tax liabilities for the periods ending Dec. 31, 2006, and Dec. 31, 2008.

The IRS issued Scott Costello a notice of intent to levy. He timely requested a Collection Due Process hearing. At the hearing, Costello's sole argument was that the LLC, and not Costello personally, was liable for the employment taxes. Notices of determination upholding the lien and levy actions were issued, and Costello filed a petition for review of the determination.

Issues: Regs. Sec. 301.7701-3(a) allows an eligible business entity other than a corporation to elect its classification for federal tax purposes. An entity with a single owner may elect to be classified as an association by filing Form 8832. Such an entity that does not file an election is disregarded as an entity separate from its owner. Costello argued before the Tax Court, however, that the LLC should nonetheless be treated as a corporation for purposes of the employment tax liability, on three grounds.

First, Costello asserted that the combination of HECI and the LLC was a valid F reorganization under Sec. 368(a)(1)(F), which resulted in a corporation. Second, he argued that the filing of Form 1120 for the first year after the merger of HECI and the LLC constituted a valid election for the LLC to be taxed as a corporation. Third, he argued that the doctrine of equitable estoppel prevented the IRS from contending that the LLC was not a corporation because of its "tacit acquiescence" to the filings of Forms 1120 for the tax years following the merger.

For employment taxes related to wages paid before Jan. 1, 2009, a disregarded entity's activities are treated in the same manner as those of a sole proprietorship, branch, or division of the owner, under Regs. Sec. 301.7701-2(a).

Holding: The Tax Court held that the LLC was disregarded as a separate entity for tax purposes. Regardless of whether the merger was a valid reorganization, to be treated as a corporation for tax purposes, the LLC was required to have so elected by filing Form 8832, for which filing a corporate tax return was not a valid substitute. And the doctrine of collateral estoppel did not apply, the court said, since the IRS made no false statement or "wrongful misleading silence" to Costello by failing to reject the LLC's Forms 1120 as the incorrect return for it to have filed.

Thus, because the employment taxes related to wages that were paid before 2009, Costello, as the LLC's sole member, was personally liable for the taxes, the court held.

  • Costello, T.C. Memo. 2016-184

—By Maria M. Pirrone, CPA, LL.M., assistant professor of accounting and taxation, St. John's University, New York City, and Joseph Trainor, CPA, Ph.D., assistant professor of accounting, St. John's University, New York City.

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