IRS Collection Alternatives: Pay Attention To Details

 

I was glancing over recent Tax Court cases when I noticed one that involved a rapper.

I’ll be honest: I do not know who this is. I am told that he used to date Kylie Jenner. There was something in the opinion, however, that caught my eye because it is so common.

Michael Stevenson filed his 2019 tax return showing federal tax liability over $2.1 million.

COMMENT: His stage name is Tyga, and the Court referred to him as “very successful.” Yep, with tax at $2.1-plus million for one year, I would say that he is very successful.

Stevenson had requested a Collection Due Process (CDP) hearing. It must have gone south, as he was now in Tax Court.

Why a CDP hearing, though?

Stevenson had a prior payment plan of $65 grand per month.

COMMENT: You and I could both live well on that.

His income had gone down, and he now needed to decrease his monthly payment.

COMMENT: I have had several of these over the years. Not impossible but not easy.

The Settlement Officer (SO) requested several things:

·      Form 433-A (think the IRS equivalent of personal financial statements)

·      Copies of bank statements

·      Copies of other relevant financial documents

·      Proof of current year estimated tax payments

Standard stuff.

The SO wanted the information on or by November 4, 2021.

Which came and went, but Stevenson had not submitted anything.

Strike One.

The SO was helpful, it appeared, and extended the due date to November 19.

Still nothing.

Strike Two.

Stevenson did send a letter to the SO on December 1.

He proposed payments of $13,000 per month. He also included Form 433-A and copies of bank statements and other documents.

COMMENT: Doing well. There is one more thing ….

The SO called Stevenson’s tax representative. She had researched and learned that Stevenson had not made estimated tax payments for the preceding nine years. She wanted an estimated tax payment for 2021, and she wanted it now.

COMMENT: Well, yes. After nine years people stop believing you.

Stevenson made an estimated tax payment on December 21. It was sizeable enough to cover his first three quarters.

COMMENT: He was learning.

The SO sent the paperwork off to a compliance unit. She requested Stevenson to continue his estimated payments into 2022 while the file was being worked. She also requested that he send her proof of payments.

The compliance unit did not work the file, and in July 2022 the SO restarted the case. She calculated a monthly payment MUCH higher than Stevenson had earlier proposed.

COMMENT: The SO estimated Stevenson’s future gross income by averaging his 2020 and (known) 2021 income. Granted, she needed a number, but this methodology may not work well with inconsistent (or declining) income. She also estimated his expenses, using his numbers when documented and tables or other sources when not.

The SO spoke with the tax representative, explaining her numbers and requesting any additional information or documentation for consideration.

COMMENT: This is code for “give me something to justify getting closer to your number than mine.”

Oh, she also wanted proof of 2022 estimated tax payments by August 22, 2022.

Yeah, you know what happened.

Strike Three.

So, Stevenson was in Tax Court charging the SO with abusing her discretion by rejecting his proposed collection alternatives.

Remember the something that caught my eye?

It is someone not understanding the weight the IRS gives to estimated tax payments while working collection alternatives.   

Hey, I get it: one is seeking collection alternatives because cash is tight. Still, within those limits, you must prioritize sending the IRS … something. I would rather argue that my client sent all he/she could than argue that he/she could not send anything at all.

And the amount of tax debt can be a factor.

How much did Stevenson owe?

$8 million.

The Court decided against Stevenson.

Here is the door closing:

The Commissioner has moved for summary judgement, contending that the undisputed facts establish that Mr. Stevenson was not in compliance with his estimated tax payment obligations and the settlement officer thus was justified in sustaining the notice of intent to levy.”

Our case this time was Stevenson v Commissioner, TC Memo 2023-115.

LLC Members and W-2s

There is a tax issue that has dogged advisors for years. 

It has to do with limited liability companies.

What sets it up is tax law from general partnerships.

A general partnership is the Gunsmoke of partnerships. The “general” does not means everybody participates. It does mean that everyone is liable if the partnership gets sued.

Whoa. There is clearly a huge downside here.

Which leads us to limited partnerships. Here only a general partner takes on that liability thing. A limited partner put his/her capital account at risk, but nothing more. Forget about signing on that bank debt.

Let’s present the granddaddy of self-employment tax law:

·        A general partner is considered self-employed and pays self-employment tax on his/her distributable income, irrespective of his/her own involvement in the trade or business.

·        A limited partner is presumed to not be involved in the trade or business of the partnership; therefore, he/she does not pay self-employment (SE)  tax on his/her distributable income.

o   There is an exception for “guaranteed payments, which is akin to a salary. Those are subject to SE tax.

How can we differentiate a general partner from a limited partner?

It is that liability thing. The entity is likely being formed under state “limited partnership” law rather than “general partnership” law. In addition, the partnership agreement will normally include a section specifying in detail that the generals run the show and the limiteds are not to speak until spoken to.

Then came the limited liability companies (LLCs).

These caused tax planners to swoon because they allowed a member to actually participate in the business without forfeiting that liability protection.

COMMENT: BTW the banks are quite aware of this. That is why the bank will likely request the member to also sign personally. Still that is preferable to being a general, where receipt of the partnership interest immediately makes you liable.

Did you catch the use of the word “member?” Equity participants in an LLC are referred to as “members,” not “partners.”

So how are LLCs taxed?

Like a partnership. 

COMMENT: I know. All we did was take that car around the block.

Let’s return to that self-employment issue: is a “member” subject to self-employment tax because he/she participates (like a general) or not subject because he/she has limited liability (like a limited)?

It would help if the IRS had published guidance in this area since the days of the Rockford Files. Many advisors, including me, reason that once the LLC is income-taxable as a partnership then it is also self-employment taxable as a partnership. That is what “like a” means. If you work there, it is self-employment income to you.

But I do not have to go far to find another accountant who disagrees with me.

What to do?

Some advisors allow their LLC member-clients to draw W-2s.

Some do not.

There is a problem, however: a member is not considered an employee. And one has to be an employee to receive a W-2.

The fallback reasoning for a long time has been that a member “is like” an employee, in the same sense that I am “like” LeBron James.

It is not technically-vigorous reasoning, and I could not guard LeBron with a squad of Marines by my side.

Then the IRS said that it would respect a single-member LLC as the employer of record, rather than going up the ownership chain to whoever the sole owner is. The IRS would henceforth treat the single-member as a corporate employer for employment taxes, although the single-member would continue to be disregarded for income tax purposes (it is confusing, I know).  The IRS included exceptions, examples and what-nots, but they did not include one that addressed LLC members directly.

The members-want-W-2s school used this notice to further argue their position. You have the LLC set-up a single-member subsidiary LLC and have the subsidiary – now considered a corporate employer – issue W-2s to the members. Voila!    

Let’s be clear why people care about this issue: estimated taxes. People do not like paying estimated taxes. It requires a chunk of money every three months. Members pay estimated taxes. Members would prefer withholding. Withholding comes out of every check, which is less painful, and don’t even talk about that three-month thing.    

The IRS has backed-off the member/W-2 issue for a long time.

However the IRS recently issued guidance that the above “parent-subsidiary” structure will not work, and taxpayers have until August 1 to comply. The IRS did this by firing its big guns: it issued Regulations. There are enhanced disclosure requirements when one takes a position contrary to Regulations, and very few practitioners care to do that. It is considered a “call me to book the audit” disclosure.

The IRS has given these advisors little more than two whole months to rope-in their errant LLC clients. 

Although the window is tight, I agree with the IRS on this one, except for that two-month thing. They feel they have floated the change long enough to alert practitioners. I would have made it effective January 1, 2017, if only for administrative ease. 

Still this is an area that needs improvement. While the IRS is concerned that member W-2s may lead to members inappropriately participating in benefit plans, there is also mounting demand for member withholding. 

Perhaps the answer is to allow withholding but to use something other than a W-2. One could design yet another 1099, and the member would attach it to his/her tax return to document the withholding. Any additional paperwork is a bother at the LLC level, but it would just join the list of bothersome things. The members wanting withholding would have to employ their powers of persuasion.

Sounds like the beginning of a compromise.