Sean McNamee was the owner of an accounting firm, W. F. McNamee & Co., LLC (WFM), which he founded and formed in Connecticut as a limited liability company (LLC). For federal tax purposes, an LLC can elect to be treated as a corporation or as a sole proprietorship by checking the appropriate box on a certain tax form. A corporation’s income is subject to double taxation— the corporation is taxed directly, and its shareholders are taxed on dividends paid to them from the income—but its owners normally are not liable if the firm does not pay its taxes. A sole proprietorship is taxed only once—the owner pays an individual’s income tax on the business’s income—but its owner is liable if the tax is not paid. In 2000, an LLC with a single owner that did not elect corporate treatment was taxed as a sole proprietorship. McNamee did not elect to have WFM treated as a corporation. During the last six months of 2000 and all of 2001,

WFM employed an average of six persons but did not pay any payroll taxes. The unpaid total was $64,736.18.WFM went out of business in 2002.The U.S. Department of the Treasury, through the Internal Revenue Service (IRS), assessed the amount of the unpaid tax against McNamee personally.

(a) McNamee objected to the IRS’s attempt to collect the tax from him, pointing to Connecticut statutes under which the members of an LLC are not personally liable for its debts. He argued that the IRS’s action was “in direct conflict with the right of an LLC member.” How would the IRS likely respond to this objection? Do you agree with McNamee or the IRS? Why? What might McNamee have done to avoid this dispute?

(b) In October 2005, the IRS proposed to amend the check-the-box regulation to relieve the owner of a single-member LLC from the possibility of personal liability for the LLC’s payroll tax liability. Does this proposal show that the check-the-box regulation under which McNamee was personally assessed with the amount of the unpaid taxes was “unethical” or “wrong”? Why or why not?