Single-Member LLCs and Payroll Tax: Disregarded for Income Tax, Not for Form 941

A single-member LLC that has not elected to be taxed as a corporation is, for income tax purposes, invisible. Its income goes on the owner's return. So it surprises owners to learn that when the LLC has employees and falls behind on Form 941, the IRS treats the LLC as a separate taxpayer.

That is not an IRS policy choice. It is in the entity classification regulations.

The Regulation

Treasury Regulation 301.7701-2(c)(2)(i) sets the general rule: a business entity with a single owner that is not a corporation is disregarded as an entity separate from its owner.

Paragraph (c)(2)(iv) carves out employment taxes. It says the general disregarded-entity rule does not apply to taxes imposed under Subtitle C, Employment Taxes and Collection of Income Tax, covering chapters 21, 22, 23, 23A, 24 and 25. Instead, an entity that is disregarded for any purpose is treated as a corporation with respect to those taxes.

The regulation's example makes it concrete. An LLC owned by one individual and otherwise disregarded is treated as separate from its owner for Subtitle C. It is liable for income tax withholding, FICA and FUTA. It must file the applicable Forms 94X, such as Form 941 and Form 940, under its own name and employer identification number, furnish Forms W-2, and make timely employment tax deposits.

Under Regulation 301.7701-2(e)(5), paragraph (c)(2)(iv) applies to wages paid on or after January 1, 2009, with the specific treatment-as-a-corporation language in (c)(2)(iv)(B) applying to wages paid on or after September 14, 2009.

Two Eras, Two Results

IRM 5.7.3.4.1 explains how the IRS handles single-member LLCs depending on when the wages were paid.

Wages paid before January 1, 2009

The LLC was disregarded for employment taxes too. According to the IRM, the single member owner is personally and fully liable for all employment taxes, not just the trust fund portion. A TFRP investigation may still be needed for other potentially responsible individuals, such as a manager.

Wages paid on or after January 1, 2009

The LLC is treated as a corporation for employment taxes. The IRM says a TFRP investigation is required. The owner is not automatically liable for the LLC's Form 941 debt. To reach the owner personally, the IRS must establish responsibility and willfulness under section 6672, the same as for a corporate officer.

That has two consequences that cut in opposite directions:

• Good news: the employer's share of FICA, FUTA, penalties and interest are LLC liabilities. The TFRP does not reach them. IRM 5.17.7.2.6 confirms the penalty does not apply to the employer's portion of FICA or to FUTA.
• Bad news: the trust fund portion can still become personal. And in a one-owner business, the owner almost always has the status, duty and authority the IRS looks for.

IRM 5.7.4.3 notes that when the single member owner and the LLC are liable taxpayers for different periods under the same EIN, typically pre-2009 and post-2009 periods, the IRS creates two separate cases in its trust fund system and handles them differently.

The Owner Is Not the LLC's Employee

Regulation 301.7701-2(c)(2)(iv)(C)(2) adds an important wrinkle. For the owner's own compensation, the LLC is still disregarded. The entity is treated like a sole proprietorship for purposes of employing its owner. The owner is not an employee of the LLC, and is subject to self-employment tax on the LLC's net earnings. The regulation's example says the owner is self-employed and not an employee of the LLC for Subtitle C purposes.

So the LLC's Form 941 covers its employees, not the owner's draws. If an owner ran personal pay through the LLC's payroll as wages, that is a classification error worth correcting. Our Form 941-X guide explains the correction process.

Multi-Member LLCs

An LLC with two or more members is classified as a partnership unless it elects corporate treatment. IRM 5.7.3.4.1 says that when an LLC is classified as a corporation or partnership, the usual procedures for determining responsibility and willfulness apply. It adds a note: a TFRP determination must be made on an LLC classified as a partnership because, under state law, members of an LLC classified as a partnership are not liable for the partnership's debts.

That differs from a general partnership, where IRM 5.17.7.2.1.3 says general partners are generally individually liable under state law for partnership debts.

Managers and Employees of the LLC

The IRS does not stop with the owner. IRM 5.7.3.4.1 lists LLC members, managers and employees among potentially responsible persons. A hired general manager or controller of an LLC can face the TFRP on the same terms as at a corporation, and the IRS's non-owner employee policy applies. See our non-owner employee guide.

Practical Implications

Check the EIN

Because the LLC must file Forms 941 and 940 under its own name and EIN, IRS notices for the LLC's payroll taxes are tied to that EIN. Make sure the IRS has the right business address, and that notices for the LLC are actually reaching you.

Look at the periods

If the LLC has been around since before 2009, old periods may be the owner's direct personal liability for all employment taxes, while newer periods are LLC liabilities with only TFRP exposure for the trust fund portion. Collection statutes and assessment dates for those old periods may matter a great deal.

Expect a TFRP investigation

For post-2008 periods, the owner should expect a Form 4180 interview and a Letter 1153 if the trust fund portion is unpaid. The defenses are the same as anyone else's: responsibility and willfulness. In a single-owner business, responsibility is usually hard to contest, so willfulness, timing and the amount often become the focus. See our guides on willfulness and the Form 4180 interview.

Pay the trust fund portion first

Since only the trust fund portion can follow the owner home, voluntary payments from the LLC should be designated to the trust fund portion of specific Form 941 quarters. Without a designation, the IRS applies payments to the employer's share first. See our designation guide.

Four Common Misconceptions

• "My LLC is disregarded, so the IRS will just add the payroll taxes to my Form 1040." Not for wages paid on or after January 1, 2009. The LLC is the employer and files under its own EIN.
• "The LLC protects me from all of it." It protects you from direct liability for the employer's share, FUTA, and business penalties and interest. It does not protect you from the TFRP on the trust fund portion.
• "I can pay myself through payroll like an employee." The regulation says the disregarded LLC is not treated as a corporation for purposes of employing its owner. The owner is self-employed.
• "The IRS has to sue the LLC first." The TFRP is an assessable penalty under section 6672 with its own notice process. The IRS uses Letter 1153 and assessment, not a lawsuit against the LLC, to reach responsible persons.

Electing Corporate Status Does Not Change the Payroll Answer

An LLC that elects to be taxed as an S corporation or C corporation is a corporation for all federal tax purposes, including employment taxes. The TFRP analysis is the same as for any corporation. The single-member regulation matters most for LLCs that never made an election and assumed "disregarded" meant disregarded for everything.

For more on how the firm handles payroll tax problems for small businesses, see the main site's payroll tax page.

Your LLC protects you from part of the payroll tax bill. Not the part withheld from your employees' paychecks. Plan around that line. Call (813) 229-7100. Let's talk.