COVID-19: What to Know About the IRS & Government Initiatives

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March 26, 2020

As a commercial lender, these developments will affect your clients (and you).

At Tax Guard, we work directly with the IRS to protect your clients, protect you, and preserve funding. As a trusted resource, we are here to help and answer your questions regarding the IRS, especially those related to recent developments, which seem to be emerging hourly. We hope this blog will help you cut through the noise and get to the facts regarding the IRS changes. For example, when you ask your client if they are making federal tax deposits and your client replies that the payroll taxes have been deferred, you will know how to respond (hint: only a portion of the payroll taxes can actually be deferred).

Undoubtedly, we will be spending a lot of time over the next several months answering questions, securing new installment agreements for our mutual clients after they default, protecting lenders’ collateral, and preserving funding – the things we do anyway. Given the level of complexity, the confusion in the media, and the sheer volume of problems, it will be more important than ever to work with a tax professional that understands the IRS as well as the concerns of the lender. We’ll be here when you need us.

Current State of the IRS

The Collections Division of the IRS is up and running. Tax Guard’s Resolution team works primarily with revenue officers, group managers, territory managers, advisors, etc. These individuals are working from home (many already worked from home, so there’s not much of a difference). Tax Guard’s Associates have secured several installment agreements and subordinations of federal tax lien over the past few weeks.

Until safety and social distancing issues are resolved, other aspects of the IRS are limited. Call centers and service centers are closed (the automated phone line is theoretically working). Taxpayer Assistance sites are closed. The IRS has suspended in-person meetings for collections, audits, etc. In short, the IRS is going to be slower than usual.

Deferred Payroll Taxes 

Section 2303 of the recently passed CARES Act allows businesses and self-employed individuals to defer payment of the employer matching portion of the Social Security tax they otherwise are responsible for paying on quarterly 941 returns. So long as one half of the deferred amount is paid no later than December 31, 2021 and the other half is paid no later than December 31, 2022, the business will be considered compliant and no penalties will be assessed. 

However, there are three components of payroll taxes – federal income (withholding), Social Security, and Medicare taxes. Businesses are still required to file and pay the withholding, employee portion of Social Security, and all Medicare taxes on time. Per the IRS’s FAQs on deferred payments, the Form 941 Employer’s Quarterly Federal Tax Return will be revised for the second calendar quarter of 2020 and instructions for deferring payments will be issued in the near future. However, the proverbial devil is in the details and it is not difficult to imagine businesses struggling with compliance issues based on these new, interim, and temporary rules.

Initiatives and Extensions

On March 25, 2020, IRS Commissioner Chuck Reitig unveiled the new “People First Initiative,” which “provides immediate relief to help people facing uncertainty over taxes.” For taxpayers under an existing installment agreement, payments due between April 1 and July 15, 2020, are suspended. Liens and levies (including any seizures of a personal residence) initiated by field revenue officers will be suspended during this period. Unfortunately, these measures do not help businesses that were unable to make payments in March; those defaulted agreements will need to be addressed.

The IRS has extended some filing deadlines as well as the deadline to make estimated income tax payments, but the scope is limited. The delays for filing and paying apply only to income tax returns (individual and business) and estimated income tax payments. Income tax returns and estimated income tax deposits due after April 1 and before July 15 can be filed and/or paid as late as July 15, 2020 without penalty. The extensions to file and pay do not apply to employment and excise tax deposits. For clarification, see the IRS’s FAQs on the filing/paying extensions.

Payroll Tax Credits Related to Paid Leave for Workers 

There are two types of payroll credits. The Employee Retention Credit, created by the CARES Act, is a fully refundable tax credit for employers equal to 50 percent of qualified wages (up to $5,000 per employee) that eligible employers pay their employees after March 12, 2020, and before January 1, 2021. An eligible employer is one that continues to pay its employees despite fully or partially suspending operation during any calendar quarter in 2020, or experiencing a “significant decline in gross receipts” during the calendar quarter. A business may not claim an Employee Retention Credit if the employer also receives a Small Business Interruption Loan under the Paycheck Protection Program authorized under the CARES Act (“Paycheck Protection Loan”). There are several other limitations, which are reviewed in detail in the IRS’s FAQs on retention credits.

The Families First Coronavirus Response Act signed into law on March 18, 2020, created the Paid Sick Leave Refundable Credit and the Payment of the Sick and Family Leave Credit. While the law requires employers to extend paid sick and family leave credits for employees affected by COVID-19, it also allows employers to offset these expenses against the employer-matching portion of the Social Security and Medicare taxes. These provisions apply to businesses with fewer than 500 employees. Additionally, businesses cannot use the same wages to claim Employee Retention Credits and Sick/Family Leave Credits. To say these provisions are complicated is a massive understatement – there are 66 “basic” questions in the IRS’s FAQs on the sick/family leave credits.

We will provide additional updates in the coming days and weeks and remain committed to being a source you can trust during these challenging times. 

For an in-depth look at these issues, check out our three-part video series.

Are You Exposed? Considerations When Funding a SMLLC

Lenders frequently ask about the differences between a limited liability company’s (LLC’s) tax consequences and its exposure to liability. The question usually takes the following form: “I have a client that operates as an LLC.  My client has personal 1040 liability stemming from income generated by the LLC that passed through to my client (on a 1040 schedule C for a sole proprietorship or through the 1065 partnership return to the K-1 to the 1040 return for a partnership). Can the IRS levy the LLC’s receivables when pursuing collection of the personal liability?”

Even though a single-member LLC or multi-member LLC may be taxed as a sole proprietorship or partnership, respectively, it is not treated as a sole proprietorship or partnership for IRS collection purposes. The IRS generally cannot levy the LLC’s receivables to collect against the individual’s personal 1040 income tax liability.

When forming a business, the choice of entity (e.g., sole proprietorship, partnership, corporation, limited liability company, etc.) has significant implications for the business. This decision affects the owners or shareholders relative to filing requirements, tax consequences, and exposure to liability – and can impact the lender as well.

Specifically, the choice of entity will impact how the IRS can collect personal 1040 liabilities (and what assets are exposed). Generally, owners should avoid operating as a sole proprietorship or partnership. There is no distinction between the individual(s) and business. Since the assets and liabilities associated with the business are also the personal assets and liabilities of the owner(s), the IRS can pursue the accounts receivable to collect on the individual’s personal liability.

The LLC provides for additional protection, but exemplifies the complexities surrounding the choice of entity. The single-member LLC can be taxed as a sole proprietorship on a 1040 return or as a corporation on a 1120 or 1120S return. The multi-member LLC can be taxed as a partnership on a 1065 return or as a corporation on a 1120 or 1120S return. The confusion, at least for IRS collection purposes, stems from the fact that sole proprietorships and partnerships are considered “disregarded” or “pass-through” entities. Disregarded entities are distinct from their owners for some purposes, but not when it comes to taxes.

Even though the single- or multi-member LLC can be taxed as a sole proprietorship or partnership, the rule is different for collection.  The IRS cannot pursue an LLC’s assets (or a corporation’s, for that matter) to collect an individual shareholder or owner’s personal 1040 federal tax liability. In short, the LLC (or corporation) has a separate and distinct taxpayer identification number from that of the individual (EIN vs SSN). Even though an LLC may be taxed as a sole proprietorship or partnership, state law indicates the taxpayer/LLC owner has no interest in the LLC’s property. The LLC is treated differently for taxation than for liability and collection.

The IRS’s chief counsel addressed the question of whether the IRS could satisfy the single-member owner’s tax liability from the disregarded LLC’s assets in a 2003 memo (Chief Counsel Advice 200338012, Jan. 1, 2003). Chief counsel reviewed the Supreme Court’s 1999 Drye decision, 528 U.S. 49 (1999), in which the Court articulated a two-prong test to determine a taxpayer’s property and rights to property.

Under the first prong of the Drye test, one looks to state law to determine a taxpayer’s interest. Generally, states conclude the taxpayer/single member owner has no interest in the LLC’s property. As such, the second prong of the test is irrelevant. “If under the first prong, a taxpayer has no interest in or rights to particular property under state law, it follows that the IRS has no right to levy the particular property under the Internal Revenue Code.” Thus, as a general rule, even though an LLC can be taxed as an entity disregarded as separate from the single- or multi-member owner, “for federal tax liability purposes, the IRS cannot satisfy the single member owner’s tax liability from the disregarded LLC’s assets.”

As with any general rule, there are exceptions. Depending on the facts and circumstances of the case, the IRS could determine that the LLC is an alter ego of the individual and/or assets were fraudulently conveyed to the LLC by the individual. Although the IRS’s use of an alter ego assessment is rare, the likelihood increases dramatically when there is commingling of assets.

Practice pointer: When funding an entity, verify that the LLC (or corporation) paperwork with the Secretary of State’s office is in good standing. If the Secretary of State requirements have not been met (e.g., annual reports filed or fees/taxes paid), the LLC’s charter or status could be revoked. If the LLC’s status is revoked by the Secretary of State, the business is operating as a sole proprietorship or partnership and the IRS can levy the business’s receivables to collect the personal 1040 taxes.

Please note: There are exceptions to all scenarios presented above and this should not be interpreted as legal advice. Should you have specific questions about your situation please feel free to contact us for a consultation.