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Limited Liability Sometimes Isn't

Legislators aren't held to 'truth in advertising' standards.  If they were, we wouldn't have "limited liability companies."  We'd have maybe "Pretty-much Limited Liability Companies Except Maybe for Taxes."  Nobody would want to call their business a PMLLCEMFT, though, so we have LLCs.

Since they were introducStocks ed in the 1980s, LLCs have largely displaced traditional partnerships when new businesses are set up.  That is because they allow owners to achieve the benefits of partnership taxation - great flexibility and only one level of taxation - without having any general partners who are personally on the hook for partnership debts.

LLCs have one other big advantage over partnerships: you don't need a partner.  The tax law provides that single-member LLCs are "disregarded" for tax purposes.  The tax law treats taxes the single-member LLC to its owner as if it weren't there.  In theory, this allows a sole proprietor to have corporation-like protection against the liabilities of his business.

Sometime things don't work so neatly in practice, as accountant Sean McNamee learned last month.  He owned an accounting firm that he set up as a single-member LLC.  Somehow he got behind on his payroll taxes by $67,000.  The IRS never takes that well.  They sued Mr. McNamee to collect the taxes.  Mr. McNamee argued that because he operated as a limited liability company under Connecticut state law, he had no personally liability for the payroll taxes, or for any other liabilities of the LLC.

The federal courts disagreed.  Both the trial judge and the appeals court said that "disregarded" means "disregarded," and that for purposes of collected the accounting firm's employment taxes, the LLC might as well have never existed.  As far as the employment taxes were concerned, Mr. McNamee's liabilities weren't limited at all.

Of course, no matter what entity you use to operate your business, you should never get behind on your payroll and withholding tax payments.  The IRS can collect from anyone who is "responsible" for remitting withheld taxes who fails to do so.  That's as true for a corporation or LLC as it is for a sole proprietor.


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