CCA 200851102: Collecting employment taxes from a husband-and-wife LLC that never filed an income tax return

Plain-English summary

This is a set of answers to seven collection questions about one recurring problem: a limited liability company owned by a husband and wife in a community property state, behind on its employment taxes, whose owners have never filed an income tax return saying how they want the entity treated.

The facts matter because the classification rules for this kind of entity are elective. Forms 941 were filed under the LLC's own name and employer identification number. Some federal tax deposits were made and some periods have balances due, and the release describes the business with the collection term of art for a company that keeps running while its trust fund arrears build behind it. Revenue officers tried to reach the couple at the address on the module, which is the couple's home, and got no response. The couple filed an extension for their individual returns but has filed nothing else, so there is no return to look at.

The classification default. Rev. Proc. 2002-69 lets a husband and wife who own a business as community property choose: treat it as a partnership and file partnership returns, and the Service accepts that, or treat it as disregarded, and the Service accepts that too. The procedure has no stated default for owners who file nothing at all, which is the gap the first question asks about. The answer is that the election is optional, and if no election is made, classification falls back to the check-the-box regulations at Treas. Reg. section 301.7701-3. Two owners means a partnership by default. One owner means a disregarded entity. Since both spouses own this business and no election was made, it is a partnership. The intuitive shortcut, that failing to file partnership returns means the entity must be disregarded, is rejected.

Assessment in the name of a disregarded LLC. For wages paid before January 1, 2009, an assessment naming the disregarded LLC is in substance an assessment of the owner's liability. Where the LLC is wholly owned by husband and wife as community property and both are members, the community is liable, so the assessment is valid against both. The advice prefers that both names be added to the assessment rather than relying on substance.

Credit reports. Here the answer is narrower than the collection function hoped. The Fair Credit Reporting Act permits a report to be pulled in connection with the review or collection of an account of the consumer. With a disregarded LLC the account belongs to the LLC, and the Form 941 is filed under an EIN rather than a Social Security number, so only the spouse who carries on the business can have a report pulled. There is no analogue here to pulling both spouses' reports on a joint income tax liability. The instruction is to decide which spouse carries on the business and pull that one. Where only one spouse is a member and the other holds a community property interest, the liable spouse's report may be pulled without a summons, and the non-liable spouse's may be obtained with one.

Substitute returns and levies. For periods before January 1, 2009, a section 6020(b) assessment follows the classification: against the LLC if it is a partnership, and against the husband and wife if they elected disregarded treatment. On levies, there is no legal requirement that an EIN or Social Security number appear on the notice, so which identifier to use is a business decision rather than a legal one.

One question left open. Whether the Notice of Federal Tax Lien should be filed in the LLC's name or the couple's is not answered. The writer says another attorney must be consulted and the answer will follow separately.

The last question asks what happens if the owners retroactively switch treatment after enforced collection and then claim a refund. The answer is that the gap between assessment and levy gives the taxpayers many chances to assert disregarded treatment, so the problem should resolve itself, and if it does not, local counsel should be contacted. That is a prediction rather than a legal conclusion, and the release presents it as one.

This is a clean digital release rather than a scan, so no OCR correction was needed. Kept as released: "Rev. Proc 2002-69" without the period after "Proc" in question 1; the check-the-box default described as applying "if there are two owners of the business" and "if there is one owner of the business," with the community property overlay left implicit; "the spouses should not be equal partners," where the surrounding reasoning suggests "need not be"; "the review or collection of an account of, the consumer[.]" with the comma as it appears; and in question 4, both the LLC-as-taxpayer and the owner-as-taxpayer clauses reading "proposed against the LLC."

Ruling snapshot

• Questions: How should the Service classify and collect against a husband-and-wife community property LLC that filed employment tax returns but no income tax return, and whose credit reports may be pulled?
• Outcome: Advice given. With no Rev. Proc. 2002-69 election, classification defaults to Treas. Reg. section 301.7701-3, and two owners means a partnership. An assessment naming a disregarded LLC is valid against both spouses as the community, though both names are preferably added. Under the Fair Credit Reporting Act only the spouse who carries on the business may have a credit report pulled without a summons. A section 6020(b) assessment follows the classification. No identifier is legally required on a notice of levy. The Notice of Federal Tax Lien question was deferred to a later email.
• Key authorities: Rev. Proc. 2002-69; Treas. Reg. section 301.7701-3; Notice 99-6; 15 U.S.C. section 1681b(a)(3)(A) (Fair Credit Reporting Act); IRC sections 6020(b), 6203, 6323, 6330, 6331; IRM 5.1.21.3.7.1(1), 5.1.21.6.5, 5.1.21.6.6, 5.1.21.6.7.

Full text (IRS public release)

ID: CCA-102393-08 Number: 200851102
Office: ------------ Release Date: 12/19/2008

UILC: 6203.00-00; 6020.00-00; 6323.00-
00; 6331.00-00; 6330.00-00

From: ------------------
Sent: Thursday, October 23, 2008 9:38 AM
To: -----------------
Cc: -----------------------------------------
Subject: Response to LLC Questions

Below is our response to the LLC questions. My reviewer concurs in the response. Thank you.

In the scenario we want to address, an LLC was established in a community property state. Forms 941 were filed using the name and EIN of the LLC. While some FTDs have been made, there are outstanding balances for some periods. The LLC appears to be a pyramiding in- business taxpayer. H and W taxpayers filed an extension for their individual income tax returns, but they have not filed any income tax returns indicating how they wish to treat the LLC for federal tax purposes since the LLC began operations.

The LLC was established under the laws of a community property state. The annual reports filed with the state indicate that the members of the LLC are H and W, and they are listed as “governing people” on their business license.

ROs have tried without success to contact H and W at the address on the module for the LLC, which is the personal residence of H and W. In the absence of any response, there is no way to determine whether H and W plan to treat the LLC as a partnership or a disregarded entity.

Under Rev. Proc. 2002-69, if the LLC and H and W, as community property owners, treat the entity as a partnership and file a partnership return, the Service will accept the position that the entity is a partnership for federal tax purposes. If the LLC and H and W, as community property owners, treat the entity as disregarded, the Service will accept that treatment for federal tax purposes. There are outstanding employment taxes, yet the taxpayers are neither treating the entity as a disregarded entity nor a partnership.

Questions:

1. The LLC is owned by husband and wife as community property. Rev. Proc 2002-69 does not
   contain a default for treatment of the entity if no income tax return has been filed. If the entity has not filed an income tax return, how should the Service treat this entity for the purposes of collection of employment taxes? Since they did not "treat the entity as a partnership for federal tax purposes and file the appropriate partnership returns" should we treat them as a disregarded entity? 2

The election under Rev. Proc. 2002-69 is optional. If no election is made, then the classification of the LLC defaults to the “check the box” regulations, Treas. Reg. § 301.7701-3. Under these regulations, if there are two owners of the business, it is automatically by default a partnership. If there is one owner of the business, it is automatically by default a disregarded entity.

The election and default rules under Rev. Proc. 2002-69 supersede the governing documents. Therefore, while both husband and wife appear as responsible individuals on the governing documents, which would imply a partnership, they can elect to have their business considered a disregarded entity. Since no returns have been filed and the husband and wife have not made an election under Rev. Proc. 2002-69, the business would be considered a partnership because both husband and wife own the business.

2. If an LLC reports employment taxes on wages paid prior to 1/1/2009 in the name and EIN of
   the LLC and the LLC is disregarded, is the assessment in the name of the LLC a valid assessment against the husband and wife?

Yes, the assessment in the name and EIN of the disregarded LLC is, in substance, an assessment of the owner’s liability. Counsel has opined in prior advice that when an LLC is wholly owned by husband and wife as community property (with both spouses being members of the LLC) and treats itself as a disregarded entity, the community (i.e., both the husband and the wife) is liable for employment taxes. [See the last bullet in IRM 5.1.21.3.7.1(1)] Therefore, an assessment in the name of the disregarded LLC is a valid assessment against both husband and wife if both are members of the disregarded LLC. Preferably, both names of the husband and wife should be added to the assessment.

If so, can the credit reports of both spouses be requested without a summons (similar to provisions which allow credit reports for both spouses to be requested for joint income tax liabilities or the credit reports of multiple partners to be requested for partnership liabilities for which all partners are directly liable)?

No, the Service may only pull the credit report of the spouse that carries on the business. Since the Form 941 is filed under the EIN (and not SSN), the only person whose credit report could be pulled due to the narrow language in the FCRA would be the person who carries the business – not the spouse. Section 1681b(a)(3)(A) of the FCRA states that a credit report may be pulled in connection with the “review or collection of an account of, the consumer[.]” The account of the consumer with a disregarded LLC is the disregarded LLC. Although the “community” is the owner of the disregarded LLC, the spouses should not be equal partners (if they were, they should be filing a partnership return, but as stated in Rev. Proc. 2002-69, the Service will not question the election). Decide which spouse carries on the business, and it is that spouse’s credit report that may be pulled.

3. In this scenario in a community property state, only one spouse is a member of the LLC. The
   other spouse has only a community property interest in the LLC. Employment taxes on wages paid prior to 1/1/09 were assessed in the name and EIN of the LLC (under Notice 99-6). Would 3

it be permissible to request the credit bureau report for only the liable spouse without a summons?

Yes, the Service may pull the credit report for the liable spouse without a summons.

Could the credit report for the non-liable spouse be requested with a summons, if necessary?

Yes, legally the credit report for the non-liable spouse may be requested with a summons.

4. If the LLC has a liability which exceeds the amount of federal tax deposits that have been
   made, according to IRM 5.1.21.6.5, when the LLC is the taxpayer, the IRC 6020(b) assessment would be proposed against the LLC. When the owner is the taxpayer, the IRC 6020(b) action would be proposed against the LLC. Against which entity would the IRC 6020(b) assessment be properly proposed?

For employment tax periods prior to January 1, 2009: If H and W have not elected to have their LLC be treated as a disregarded entity, it is a partnership. Because the LLC is considered a partnership, the 6020(b) assessment should be proposed against the LLC.

If H and W had elected to have the LLC treated as disregarded, then the real taxpayer for a disregarded LLC is the member (in this case, the community). The assessment for a disregarded LLC can be assessed against H and W.

5. Prior Counsel advice has indicated that if the CDP notice contains both the name of the LLC
   and the name of the owner, it is valid as long as it was mailed to the last known address of the taxpayer. Since the LLC and H and W share the same address, it would appear the L-1058 would be valid, regardless of which entity is the liable taxpayer. In the event that the taxpayer fails to respond to the Letter 1058, IRM 5.1.21.6.6 and IRM 5.1.21.6.7 state that the taxpayer must be properly identified on the NFTL or levy. Should the Notice of Federal Tax Lien be filed in the name of the LLC or the names of the husband and wife?

We are waiting to consult with another attorney about this question and will answer this in a separate e-mail.

6. Presumably, if the LLC is determined to be the liable taxpayer, the levy would include the
   EIN of the LLC, and be valid against LLC assets. If H and W are determined to be the liable taxpayers, the levy would include the EIN assigned to them, as well as their SSN(s). Should any Notices of Levy contain the EIN of the LLC or the EIN/SSN(s) of the husband and wife?

There is no legal requirement that an EIN or an SSN must be on the Notice of Levy. Whether the EIN or SSN should be used is a business decision of the Service. 4

7. Further questions are generated by the fact that there are no restrictions to prevent an LLC
   and the H and W who own it as community property from filing amended returns and retroactively changing the way they treat the entity for federal tax purposes (other than the requirement that any change in reporting position will be treated for federal tax purposes as a conversion of the entity). If they had treated the entity as a partnership, and the Service took enforced collection action against the LLC, would they be entitled to a claim for refund if they subsequently filed returns treating the entity as a disregarded entity?

In the time between when the Service assesses and when the Service levies, this should be resolved. There are numerous opportunities before the Service enforces collection action when the taxpayers could assert their desire to be considered a disregarded entity. Therefore, this should not become an issue. If it does become an issue, contact local counsel.