IRS explains how to collect from sole member of LLC law firm Chief Counsel Advice 200836002
In Chief Counsel Advice (CCA), IRS has concluded that a levy served on a limited liability company (LLC) will attach to property or rights to property belonging to the LLC’s sole owner. He practiced law and received income from the LLC from contingent fee agreements between the LLC and clients. The CCA further concluded that if payments being made to the sole owner are in the nature of salary or wages, IRS may be able to serve a continuing wage levy on the LLC to reach the payments.
Background. IRS can enforce a lien created by Code Sec. 6321 in two ways. It can bring a foreclosure action under Code Sec. 7403 or it can levy on the taxpayer’s property under Code Sec. 6331. Unlike a foreclosure action, the levy is a provisional, administrative procedure, and it generally reaches only property possessed and obligations existing at the time of the levy–the “fixed and determinable” requirement. (Code Sec. 6331(b), Reg. § 301.6331-1(a)(1)) However, an exception to this rule under Code Sec. 6331(e) authorizes a continuing levy on salary or wages.
In U.S. v. Jefferson-Pilot Life Ins. Co., (CA4 1995) 75 AFTR 2d 95-1529, the Fourth Circuit held that Code Sec. 6331(e) ‘s continuing levy provision applied to commissions payable to an independent contractor insurance salesman. In Moskowitz, Passman & Edelman, (DC NY 10/09/2007) 100 AFTR 2d 2007-6358, a district court held that amounts paid and payable to a member law firm, organized as a partnership, were subject to a continuing levy.
Facts. Taxpayer, an attorney who practices law, had his business organized as an LLC under State A law. He was the sole owner of the LLC. He owed taxes for multiple tax years, and IRS filed Notices of Federal Tax Lien (NFTL) for several of those years. however, the limitation period on collection under Code Sec. 6502 had expired for some of the earlier liabilities.
The only potential asset that IRS identified as available to satisfy his liabilities was the income paid to him by the LLC generated by the LLC’s sporadic stream of accounts receivable from personal injury contingent fee agreements. These agreements were between the LLC and the clients who need legal services. A client would agree to pay the LLC immediately on completion of his case 33% of the total gross recovery realized by settlement, or 40% if the case did not settle within three weeks before trial. The contingent fee agreements didn’t generate receipts with any pattern of regularity. Rather, money flows into the LLC when Taxpayer was successful in a lawsuit. Taxpayer won a few cases per year, and the amount of his law practice gross was deposited in the LLC’s bank account. Taxpayer reported his income for federal tax purposes as net profits from the operation of a business (Schedule C). He also incurred self-employment tax. Taxpayer refused to cooperate with IRS Collections and wouldn’t agree to satisfy his tax liabilities voluntarily through an installment agreement or otherwise.
IRS‘s Collections requested assistance in the most effective way to collect Taxpayer’s outstanding tax liability.
Observation: The CCA noted that Collections correctly observed that absent an alter-ego relationship, IRS couldn’t levy on the LLC’s assets to satisfy the single-owner’s debts. Seizing Taxpayer’s interest in the LLC was not considered a viable option because there were no other owners interested in purchasing it.
Tax collection. As a threshold matter, the CCA concluded that the LLC held property or rights to property of Taxpayer subject to levy. Taxpayer’s right to receive income from the LLC was “property” or a “right to property” under State A. The CCA based its conclusion on the fact that State A created a statutory right in the member of an LLC to be repaid his capital contribution and to share equally in the LLC’s profits. In the CCA’s view, this right was a property right under State A law.
The CCA found that, as a matter of federal law, a notice of levy served on the LLC would obligate it to turn over the income to which Taxpayer was entitled to receive as a consequence of rendering legal services. In order for the LLC to be obligated to turn over property or monies to IRS, it must be in possession of Taxpayer’s property or be obligated to Taxpayer at the time of levy. Courts have held that the “fixed and determinable” requirement in Reg. § 301.6331-1(a)(1) is satisfied when the events which give rise to the obligation have occurred, and the amount of the obligation is capable of being determined in the future. (U.S. v. Hemmen, (CA9 4/07/1995) 75 AFTR 2d 95-1646, CPS Electric, Ltd v. U.S., (DC NY 2002) 89 AFTR 2d 2002-2319 , U.S. v. Antonio, (D. Haw. 1991) 71A AFTR 2d 93-4578) Under the rationale of these and other cases, the CCA found that the LLC’s obligation to Taxpayer was “fixed and determinable” when the LLC receives a contingent fee following successful litigation and after setting aside a reserve for overhead expenses.
The CCA noted that IRS didn’t take the position that future payments that may be made under an existing contingent fee agreement were fixed and determinable as to Taxpayer because the contingent fee agreement was between the LLC and the client, not between Taxpayer and the client. State A law provided: “Property transferred to or otherwise acquired by a limited liability company is the property of the company and is not the property of the members individually.” Under this provision and the courts’ interpretation of , the LLC, not Taxpayer, held the right to be paid from successful lawsuits or settlements under the contingent fee contracts.
Although IRS can serve a Notice of Levy (Form 668-A) on the LLC to seize the property belonging to Taxpayer or obligations owed to Taxpayer, it also may–on conducting further factual development–be able to serve a Notice of Levy on Wages, Salary, and Other Income (Form 668-W). The CCA concluded that based on Jefferson-Pilot and Moskowitz, the payments Taxpayer received from the LLC as his net profits may be subject to Code Sec. 6331(e) ‘s continuing wage levy provision. These two courts based their decision on the fact that the remunerations were paid out to the delinquent taxpayers on a recurring basis. There is a possibility that with further information IRS can characterize the profits Taxpayer receives from the LLC as income subject to a continuing wage or salary levy.