Federal courts have recently issued rulings on: (1) whether medical residents may qualify for the student FICA exception, (2) whether an employee’s embezzlement was reasonable cause for failing to remit withholding taxes, and (3) whether the sole owner of a limited liability company (LLC) may be held liable for the LLC’s unpaid employment taxes.
Student FICA exception. The U.S. Courts of Appeals for the Second Circuit and Sixth Circuit have both recently ruled that an analysis of the facts is required before determining whether wages paid to medical residents may be exempt from FICA tax. Federal law does not specifically bar this exemption [U.S. v. Memorial Sloan-Kettering Cancer Center et al., CA2, 103 AFTR 2d ¶ 2009-666, 3/25/09; U.S. v. Detroit Medical Center, CA6, 103 AFTR 2d 2009-541, 2/26/09].
Observation: This is not a new issue. The Courts of Appeals have previously issued several similar rulings on this topic, including University of Chicago Hospitals v. United States, and U.S. v. Mount Sinai Medical Center of Florida Inc.
Employee embezzlement. A federal district court has ruled that the sole owner of two home health care companies that were delinquent in paying employment taxes could be subject to the trust fund recovery penalty, even though two of his employees stole money from him [Anuforo v. Commissioner of Internal Revenue, DC Minn., 103 AFTR 2d ¶2009-1020, Dkt. No. 07-1756, 1/14/09].
IRC §6672 imposes a penalty on any person who is required to collect, truthfully account for, and pay over withheld income and Social Security taxes and who willfully fails to do so. The amount of the penalty is equal to the amount of the tax that was not collected and paid. The penalty is often referred to as the “trust fund recovery penalty” (TFRP). The penalty is imposed on a “responsible person.” A “responsible person” is anyone within a corporation or partnership who has the duty to collect, account for, or pay over the tax.
The court determined that the owner was a responsible person, based on the owner’s own admission to such status. He was the only person with hiring/firing, bill paying, contract negotiation, and tax payment authority. His willfulness was shown by fact that he paid other creditors while aware of growing, unpaid tax debts. The fact that employees embezzled corporate funds didn’t excuse the owner from liability, particularly where the embezzlement only occurred in a few of the tax periods at issue.
Sole owner of LLC. The Tax Court has ruled that the IRS may pursue a collection action against the sole owner of an LLC for the LLC’s unpaid employment taxes [Medical Practice Solutions LLC, Carolyn Britton, Sole Member, 132 TC No. 7, 3-31-09].
Reg. § 301.7701-2(a) allows an unincorporated business entity (e.g., an LLC) that has only one owner the option of being classified either as an association (defined in Reg. § 301.7701-2(b)(2) as a corporation), or as a “sole proprietorship,” that is, to be “disregarded as an entity separate from its owner.” Reg. § 301.7701-2(a) (known as the “check-the-box” regs) allows the above entity to choose how it would like to be taxed by filing IRS Form 8832, Entity Classification Election. An entity that doesn’t file this form is disregarded as a separate entity, which results in tax being assessed at the personal income tax level.
Medical Practice Solutions was a single-member LLC with Carolyn Britton as its sole member. She treated the LLC as a sole proprietorship on her personal income tax return. She did not elect to have the LLC treated as a corporation for federal income tax purposes.
After Medical Practice Solutions failed to pay employment taxes for several periods in 2006, the IRS sent notices of lien and intent to levy to Britton. Following a hearing, a notice of determination sustaining lien and proposed levy was sent to Britton, pursuant to Reg. § 301.7701-3(b) of the check-the-box regs. Britton contended that only the LLC was liable and that the check-the-box regs (as applicable to employment taxes related to wages paid before Jan. 1, 2009) were invalid. She asserted that the LLC was the employer liable for the taxes.
The Tax Court concluded that the collection action could proceed against Britton. It cited several previous rulings in reaching its conclusion, including McNamee v. Treasury.
There are new check-the-box regs in effect beginning with wages paid after Dec. 31, 2008. The regs require disregarded entities to pay their own employment taxes and file their own employment tax reports.