Single-Member Owners of Disregarded LLCs Should Receive Separate Due Process Notices

A limited liability company (LLC) is a hybrid entity created under state law, with attributes of both a partnership and a corporation. The owners of an LLC are the members, who generally are not liable for the LLC's debts. An LLC may own property in its own name, and members have no interest in such property. The law of most states permits organization of single-member LLCs (SMLLCs).

Regs. Sec. 301.7701-1 et seq. (check-the-box regulations) provides a framework for the Federal tax classification of entities. An LLC's classification will depend on the number of members and any election filed for it. For example, an LLC may be either a multi-member or SMLLC. If it is a multi-member LLC, it could elect treatment as an association taxable as a corporation. If no election is made, Regs. Sec. 301.7701-3(b)(1)(i) provides that the multi-member LLC will be treated as a partnership.

If an LLC is an SMLLC, the question is whether it will be treated as an association (taxable as a corporation) or as a disregarded entity. A single-member owner of an LLC could elect to have it classified as an association taxable as a corporation. If no election is made, Regs. Sec. 301.7701-3(b)(1)(ii) provides that the LLC will be disregarded as an entity separate from its owner. A disregarded LLC's "activities are treated in the same manner as a sole proprietorship, branch, or division of the owner."

Because a disregarded LLC is not separate from its owner, the Service may seek to collect the taxes arising from the LLC's business directly from the single-member owner by administrative collection action, including filing a Notice of Federal Tax Lien (NFTL). In pursuing administrative collection action, collection due process (CDP) rights under Secs. 6320 and 6330 must be accorded the single-member-owner taxpayer.

As a general rule, a disregarded SMLLC has no filing obligation; all its activities are reported by the company's sole owner. As an exception, Notice 99-6 permitted a disregarded LLC to separately calculate, report and pay its employment tax obligation for its employees, under its own name and employer identification number (EIN). The notice makes clear that the owner of an SMLLC treated as a disregarded entity for Federal tax purposes is the employer for employment tax liability purposes. Consequently, the owner retains ultimate responsibility for the employment tax obligations incurred for the disregarded entity's employees. Thus, as a disregarded entity, an SMLLC cannot be the employer for employment tax purposes, regardless of the fact that it files employment tax returns.

When the employment tax liability is reported by the disregarded LLC pursuant to Notice 99-6, the IRS's current practice is to assess employment taxes in the LLC's name and EIN. Consequently, a disregarded LLC is often assessed for the employment tax liabilities that are the ultimate responsibility of the company's single-member owner. Also, the Service makes notice and demand for payment on the disregarded LLC.

Example: The IRS has made an assessment against a disregarded LLC and has made notice and demand for payment on the LLC. Looking to collect the tax liability, the Service has provided CDP notices under both Secs. 6320 and 6330 to the disregarded LLC. Subsequently, the IRS adds the single-member owner's name to the assessment made against the disregarded LLC.

Analysis

Sec. 6201 authorizes the Service to assess the taxpayer's liability. The IRS's position on assessments against disregarded LLCs is that assessments, notices and demand under the name or taxpayer identification number or both of a disregarded LLC are valid against the single-member owner. This is consistent with the notion that notices containing technical defects are valid if the taxpayer has not been prejudiced or misled by the error and is afforded a meaningful opportunity to litigate his claims. In substance, a disregarded LLC is a trade name by which the company's sole owner conducts business. Given the close relationship between an SMLLC and its sole owner, any reference in an assessment to a disregarded LLC and notice to the LLC is tantamount to an assessment and notice to the single-member owner.

Accordingly, notice and demand for payment made on the disregarded LLC serves as notice and demand for payment under Sec. 6303 on the single-member owner who actually received the notice and was not prejudiced by the Service's error. Given the disregarded status of the LLC for all Federal tax purposes and its close relationship to its single-member owner, the owner who actually receives the notice and demand addressed to the disregarded LLC and is not prejudiced by the IRS's mistake cannot seriously object to the notice's validity.

When an assessment and notice and demand are made on the disregarded LLC, the Service typically adds the single-member owner's name to the assessment to facilitate collection against the owner. The question arises whether this procedure requires the IRS to send a new CDP notice to the single-member owner.

There is no clear answer to this question. On the one hand, it could be argued that there is no need to send a new CDP notice to the single-member owner who actually received a CDP notice addressed to the disregarded LLC and was not prejudiced by the Service's mistake. Essentially, the IRS will apply the standard for determining the validity of a notice under Sec. 6303 to CDP notices. Under Sec. 6303, the Service is not required to identify the taxpayer correctly when the taxpayer should recognize that the notice applies to his tax liability. There is nothing in Secs. 6320 or 6330 indicating that Congress intended to impose a more exacting standard for providing a CDP notice than the notice standard under Sec. 6303.

However, it could also be argued that the standard for providing notice under Sec. 6303 does not apply to CDP notices, because CDP notices serve a different purpose. Specifically, a CDP notice alerts a taxpayer that a limited period exists for filing a request for a CDP hearing. There is no similar right to a hearing under Sec. 6303. Moreover, recognizing that a taxpayer has a limited time in which to request a CDP hearing, Congress could have intended that CDP notices correctly identify the taxpayer so that there would not be any confusion or delay. A CDP notice addressed to a disregarded LLC may cause confusion and mislead a single-member owner, because the single-member owner may believe that the IRS intends to take collection action against the disregarded LLC's assets. The single-member owner may not grasp the abstract tax concept that the LLC is disregarded for Federal tax purposes and that the Service is actually seeking to collect the tax liability from the single-member owner's assets.

Finally, requiring that a CDP notice identify the taxpayer correctly comports with the overall legislative intent underlying the CDP hearings, which was to provide greater safeguards to a taxpayer during the IRS's collection process. Requiring the Service to issue a CDP notice correctly identifying the taxpayer gives taxpayers greater protection.

The IRS should send a new CDP notice addressed to the single-member owner, even when the single-member owner actually received a CDP notice addressed to the disregarded LLC and was not prejudiced by the Service's mistake. This cautious approach will ensure that a single-member owner's CDP rights will be protected.

Chief Counsel Advice (CCA) 200216028 (3/20/02)