From Federal Tax Weekly, April 19, 2007
In a case of first impression, the Sixth Circuit Court of Appeals has turned back a challenge to the “check-the-box” business entity classification regs. A taxpayer who did not elect to treat several limited liability companies (LLCs) he owned as corporations under the check-the-box regs was personally liable for unpaid federal employment taxes
Comment: “The check-the-box rules had never been attacked before,” Lev Martyniuk, a partner with Deters, Benzinger & LaVelle, P S.C., Cincinnati, Ohio, told CCH. “They were taken as a given by many people.”
The taxpayer owned several businesses. Each of the businesses was organized as art LLC and the taxpayer was the sole member. He did not elect to treat the LLCs as corporations for federal tax purposes, which resulted in the IRS treating them as sole proprietorships.
The IRS eventually determined that the taxpayer owed more than $I million in unpaid employment taxes. Because the LLCs were treated as disregarded entities, the taxpayer was personally liable for the taxes. Subsequently, the IRS moved to enforce liens against his property to collect the taxes.
Comment: Martyniuk noted that the IRS could have sought to collect the employment taxes from the taxpayer as a controlling person. Instead, the IRS went after him as a sole proprietor.
District court decision
The taxpayer challenged the check-the-box provisions in federal district court.
The district court found that the statute underlying the regs was ambiguous and the IRS’s regulatory interpretation was a reasonable response to the changes in the state law industry of business formation. Undeterred, the taxpayer appealed to the Sixth Circuit.
Sixth Circuit’s analysis
The Sixth Circuit agreed with the district court The check-the-box regs were developed to fill in gaps in the statute. They are a reasonable and permissible interpretation of Congress’ intent, the court reiterated.
The court further found that the IRS did not have to recognize the separate existence of the LLCs as a matter or state law. The federal government has long disregarded state classifications of businesses for some federal tax purposes, the court found.
Finally, the court rejected the taxpayer’s claim that proposed regs would insulate him from liability for the unpaid employment taxes as they had not been made final.