Combining an LLC with a Corporation

October 21, 2016 by Leave a Comment

Today’s guest post is by Jim Maule, Professor Emeritus at Villanova Widger School of Law and one of the original tax law bloggers. This post, which originally appeared on Mauled Again, on October 10, 2016, discusses who is liable for employment tax when an LLC fails to remit employment taxes following a merger of a C Corp with a single-member LLC. It sweeps in some interesting procedural issues, including the importance of filing required forms to ensure that an LLC is treated as a corporation if one wants it to be treated as a corporation and the uphill battle facing taxpayers who claim IRS should be estopped from taking a position because it has accepted a filing in past years. Les

A recent Tax Court decision, Costello v. Comr., T.C. Memo 2016-184, provides helpful instructions about what to do and not to do when combining an LLC with a corporation. Though it’s too late for the taxpayer in that case, there are lessons that should prove helpful to others facing the issue in the future.

The case involved collection actions for employment tax liabilities. The resolution required identifying the tax status of the employer. Though the amount of the tax liabilities was undisputed, the issue required identification of the responsible taxpayer.

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In 1989, the taxpayer’s father incorporated Heber E. Costello, Inc. (HECI). The taxpayer’s father was thesole shareholder of HECI. HECI filed Form 1120 for each of its taxable years. At some point before 2004, the taxpayer’s father died and the taxpayer became the sole owner of HECI.

On December 31, 2003, the taxpayer formed an LLC. He was the sole member. The LLC never filed Form 8832, Entity Classification Election. On December 31, 2003, HECI and LLC merged – though the better word would be “combined” – and HECI ceased to exist. After the combination, the LLC filed Forms 1120 using HECI’s employer identification number. The taxpayer filed Forms 940 and 941 on behalf of the LLC but did not make sufficient tax deposits or pay the tax due for its employment tax liabilities 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 December 31, 2006 and 2008. The IRS issued a notice of intent to levy (NOIL) on June 1, 2011, for all of those periods and a notice of Federal tax lien (NFTL) filing on December 13, 2011, for all those periods other than 2006. The taxpayer timely submitted Forms 12153, Request for a Collection Due Process or Equivalent Hearing (CDP hearing), on June 26, 2011, and January 6, 2012, in response to the NOIL and the NFTL filing, respectively. The taxpayer indicated he could not pay the liabilities and wanted either an installment agreement or an offer-in-compromise (OIC). Though it was unclear if an OIC was submitted, it appears that any OIC would have been based on his argument that he was not individually liable for the LLC’s employment tax liabilities, which is the same argument he made before the Court. The taxpayer’s CDP hearing requests indicated he wanted Appeals to consider the abatement of taxes. Though asked to do so, the taxpayer did not submit a Form 433-A or any collection alternatives before the hearing. When an Appeals official met with the taxpayer’s representative, the taxpayer did not submit an OIC or any other collection alternatives to Appeals, nor did he present any argument with respect to the abatement of taxes. Instead, the taxpayer argued that the LLC, and not the taxpayer personally, is liable for the LLC’s employment taxes. The IRS issued the notices of determination upholding the proposed lien and levy actions on November 28 and December 3, 2012, respectively. Petitioner timely filed a petition for review of the determination.

After dealing with procedural issues, the Tax Court turned to the substantive question of whether the LLC or the taxpayer was liable for the employment taxes. The court explained that a single-member LLC is disregarded as a separate entity for federal tax purposes unless it elects to be treated as a corporation. The LLC did not file the election. Therefore, it was a disregarded entity.

The taxpayer, however, advanced three arguments in support of his position that the LLC should be treated as a corporation. The Tax Court rejected all three.

First, the taxpayer argued that the combination of HECI and the LLC was a valid F reorganization, and that the resulting entity was a corporation. The court concluded that regardless of whether the combination qualified as a F reorganization, the failure of the LLC to file Form 8832 electing to be a corporation kept it from being a corporation. Though the court did not directly answer the question, is it possible for a disregarded entity to enter into an F reorganization? Logically, the conclusion would appear to be no, because an F reorganization requires a mere change in identity, form, or place of incorporation, and in this case HECI disappeared, and the LLC did not change its identity or form, nor did it have a place of incorporation to change.

Second, the taxpayer argued that by filing Form 1120 for the first taxable year after the combining of HECI and the LLC was a valid election by the LLC to be treated as a corporation. The Tax Court concluded that the election to be treated as a corporation must be made on Form 8832 and is not made simply by filing a Form 1120.

Third, the taxpayer argued that the doctrine of equitable estoppel prevented the IRS from arguing that the LLC is not a corporation because of its “tacit acquiescence” to the filings of Forms 1120 for the year of the combination and subsequent years. The Tax Court concluded that equitable estoppel did not apply, because it requires proof that the IRS made a false representation or wrongful misleading silence, proof that the error was in a statement of fact and not in an opinion or a statement of law, proof that the taxpayer was ignorant of the true facts, and proof that the taxpayer was adversely affected by the acts or statements of the person against whom estoppel is claimed. The court explained that the IRS made no false statements to the taxpayer, and its failure to reject the LLC’s Forms 1120 was not a wrongful misleading silence. The court also explained that the taxpayer knew that the LLC had never filed a Form 8832 to be treated as a corporation.

For wages paid in the years in question, the activities of a disregarded entity are treated in the same manner as those of a sole proprietorship, branch, or division of the owner. Thus, the sole member of an LLC and the LLC itself are a single taxpayer or person personally liable for purposes of employment tax reporting and wages paid before January 1, 2009 [Ed: Regulations now provide that as of January 1, 2009, limited liability companies that are disregarded for all other purposes are treated as corporations for Federal employment tax purposes]. That left the taxpayer liable for the LLC’s unpaid employment tax liabilities.

The lesson is clear. If the member or members of an LLC want the LLC to be treated as a corporation, file Form 8832. There is no alternative. As complicated as tax law is, the filing of Form 8832 is one of the easier tasks to undertake. Though deciding whether to treat the LLC as a corporation requires somewhat more sophisticated judgments, projections, and planning, once the decision is made, the filing of the form is not difficult.

 

 

Filed Under: Disregarded Entities, Employment Taxes Tagged With:

Another Reason Tax Professors Don’t Need to Invent Hypotheticals 

January 27, 2016 by 3 Comments

Today’s guest post is from Professor James Edward Maule, a colleague of mine and Keith’s at Villanova’s Charles Widger School of Law, who many moons ago taught Stephen in Villanova’s Graduate Tax Program. This post originally appeared earlier this month in Mauled Again, Jim’s eclectic blog that in his words offers “more than occasional commentary on tax law, legal education, the First Amendment, religion, and law generally, with sporadic attempts to connect all of this to genealogy, theology, music, model trains, and chocolate chip cookies.” Jim’s blog was an inspiration to us, and his creative mind and far-reaching interests have touched on many topics (in the last few weeks alone he has discussed a proposal to include driver license numbers to reduce identity theft, taxation of powerball winnings, and genealogy). He also years ago when I transitioned from the tax clinic to teaching doctrinal courses offered up a generous series of posts that contained his views on how and what to teach in a Basic Income Tax Course, leading a tax prof colleague to refer to Jim as the “Yoda of tax teachers.”

In this post, Jim offers some thoughts on a recent Tax Court case that has the ingredients of a bad movie, but also sweeps in some interesting procedural issues relating to collateral estoppel and rescission. Les

A recent Tax Court decision, Blagaich v. Comr., T. C. Memo 2016-2 should provide some interesting classroom questions for those teaching the basic federal income tax course. It also is providing some interesting insights for myself, and hopefully for readers of MauledAgain (and now Procedurally Taxing).

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The taxpayer was involved in a romantic relationship with Lewis E. Burns from late 2009 until early 2011. During 2010, when the taxpayer was 54 and Burns was 72, he transferred to her property worth at least $743, 819, including cash and a Corvette. At the end of November in that year, the taxpayer and Burns entered into a written agreement intended to confirm their commitment to each other and to provide financial accommodation for her. They had no intention to marry and the agreement was, at least in some respects, intended to formalize their “respect, appreciation and affection for each other” in the way a marriage otherwise would do. The agreement provided that the parties “shall respect each other and shall continue to spend time with each other consistent with their past practice”, and that both “shall be faithful to each other and shall refrain from engaging in intimate or other romantic relations with any other individual”. The agreement also required Burns to make an immediate payment of $400,000 to the taxpayer, which he did. Soon thereafter, the relationship soured, an on March 10, 2011, the taxpayer moved out of Burns’ house, and on the next day he sent her a notice of termination of the agreement. Shortly thereafter, he concluded that she had been involved in a romantic relationship with another man throughout the relationship between himself and the taxpayer.

In late March of 2011, Burns sued the taxpayer in the Circuit Court for the Eighteenth Judicial District, DuPage County, Illinois, seeking nullification of the agreement, return of the Corvette and a diamond ring, and an order directing the taxpayer to return cash “and other accommodations” that Burns had provided to her, totaling more than $700,000. On April 8, 2011, Burns caused there to be filed with the IRS a Form 1099-MISC, reporting a transfer to the taxpayer of $743,819 in 2010. Based on the Form 1099, the IRS asserted a deficiency against the taxpayer, who filed a petition in the Tax Court on March 8, 2013. The IRS learned of the state court action and in May of 2103 requested the taxpayer’s attorney to provide copies of depositions taken in the case, any filings and motions relating to the Form 1099-MISC, and the fraudulent inducement claim asserted by Burns. In October 2013, the taxpayer moved for a continuance, reporting that the IRS did not object, and the Tax Court granted the motion. At some point during this time, Burns died.

In November 2013, after trial, the state court found that the taxpayer had fraudulently induced Burns to enter into the agreement, and entered a judgment ordering her to pay $400,000 to Burns’ Estate. The court held that the Corvette, the ring, and $273,819 in checks were “clearly gifts” to the taxpayer that she was entitled to keep. Subsequently, the executors of the estate caused an amended Form 1099-MISC to be issued, reporting $400,000 of income, and noting that the taxpayer had paid the $400,000 pursuant to the state court order.

The taxpayer then moved in the Tax Court for summary adjudication. The taxpayer relied on two arguments.

First, the taxpayer argued that $343,819 of the amount transferred to her by Burns was excluded from gross income as “clearly gifts.” She also argued that the IRS was estopped by the state court decision from denying that this amount represented gifts. The IRS argued that it was not so estopped because it was not a party nor in privity with any party in the state court action. The Tax Court agreed with the IRS and rejected the taxpayer’s collateral estoppel claim. The court rejected the idea that the IRS was estopped because it took steps to keep itself informed about the state court action. It also rejected the argument that the IRS bound itself to the outcome of the state court case by agreeing to a continuance in the Tax Court proceedings.

Second, the taxpayer also argued that the $400,000 portion of the transfers was not gross income under the doctrine of rescission. In other words, because she returned the money she ought to be treated as having not received it in the first place. The IRS argued that the doctrine of rescission was not applicable because the taxpayer did not return the $400,000 to Burns in 2010. The Tax Court agreed with the IRS, explaining that the doctrine of rescission is a narrow exception to the claim of right doctrine, which requires cash method taxpayers to include gross income in the year received if acquired without consensual recognition, express or implied, of an obligation to repay and without restriction as to disposition. The doctrine of rescission applies if the amount that is received is returned within the same taxable year. The Tax Court rejected the taxpayer’s reliance on cases in which the obligation to return the amounts that had been received had been acknowledged in the year of receipt even though actual repayment was made following that year, because in this instance the taxpayer did not acknowledge, in 2010, any obligation to return the $400,000.

Accordingly, the Tax Court issued an order denying the taxpayer’s motion for summary adjudication. Whether any portion of the $743,819 constitutes gross income to the taxpayer, or can be excluded as a gift, remains to be decided. Though it has been reported that the $400,000 payment for being monogamous was gross income, the taxpayer still has the opportunity to argue that the amounts received were gifts, particularly the amounts received before she and Burns entered into the agreement. Whether she succeeds remains to be seen.

For students in the basic federal income tax class, the question is simple. “Suppose your romantic partner pays you to remain monogamous. Do you have gross income?” When a student objects that “no one does that,” there now is proof that people do. Perhaps not very many people, but sometimes the most interesting tax cases arise from activities in which very few people participate.

 

Filed Under: collateral estoppel Tagged With: