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Not just Anyone can be a partner.

October 27, 2009

It's not enough to have an LLC. How you own it and how well you document it matter a lot, as a Michigander learned the hard way in Tax Court yesterday.

The taxpayer set up an LLC that ran an employment service. The LLC got behind on its payroll taxes. The IRS said that the LLC had only one owner, making it a disregarded entity, and that owner was on the hook for the employment taxes.

The taxpayer argued that he wasn't the owner at all. He said a controlled corporation owned the LLC, called Paradym, was the owner. He failed to convince the Tax Court:

Petitioner's argument that Back Porch Workout owned Paradym is not credible. Petitioner formed Paradym, and he has not offered any evidence to indicate that he transferred any of his membership units in Paradym since it was formed. Since its inception, petitioner has held himself out as owner of Paradym.

Although petitioner offered a Form 1065, U.S. Return of Partnership Income, for Paradym for tax year 2005, that document is not credible. Attached to the Form 1065 were two Schedules K1, Partner's Share of Income, Deductions, Credits, etc. The first Schedule K-1 was issued to Back Porch Workout and indicated that Back Porch Workout owned a 100-percent ownership interest in Paradym. The second Schedule K-1 was issued to "Anyone" with an address listed as "None" in Kalamazoo, Michigan. The purported Schedule K-1 showed a zero-percent ownership interest in Paradym. Not only was the Form 1065 created in 2007 after respondent had begun collection proceedings, but petitioner testified that the second Schedule K-1 was fabricated because it was the only way to process a partnership return for Paradym using petitioner's and Mr. Idahosa's tax return preparation software.

The judge wasn't convinced, ruling that the taxpayer owned the LLC, the LLC is a disregarded entity, and the taxpayer is on the hook.

The Moral: Pay your payroll taxes, and don't wait until the IRS collections people are involved to try to put them in another entity.

Cite: Comensoli, T.C. Mmeo 2009-242