LLC Manager Establishes Reasonable Cause for Failing to Honor IRS Levies and Escapes 50 Percent Penalty. (Parker Tax Publishing January 2014)

The manager of a limited liability company was not personally liable for his failure to honor certain tax levies issued by the IRS because he established that there was a bona fide dispute over the effectiveness of the levies and, therefore, he had reasonable cause not to honor the levies. U.S. v. 911 Management, LLC, 2014 PTC 3 (D. Ore. 1/2/14).

Daniel Dent was the sole manager of 911 Management, LLC, until its dissolution in 2010. Daniel was the only person authorized to conduct business and make payments on behalf of 911 Management. The company had three members, including Kathy Weathers, who was allocated a 35 percent distribution of the LLC's profits. In 2005, Kathy and her husband, Thomas, were convicted of tax evasion and failing to file tax returns. Thomas was sentenced to prison.

Beginning in 2006, 911 Management made guaranteed membership distributions to Kathy on a monthly basis. In 2007, two license agreements were created under which 911 Management would operate and receive the income from two hotels leased by Kathy and Thomas. In exchange, the Weathers couple would receive a license fee equal to 3 percent of the monthly gross proceeds generated from the hotel operations. In 2007, the IRS served three notices of levy against the bank accounts of 911 Management to satisfy Kathy and Thomas's outstanding federal tax liabilities for tax years 1996 through 2005. In response, 911 Management filed an action against the government for wrongful levy.

In February 2008, the IRS served two notices of levy on 911 Management and Daniel to collect some of Kathy and Thomas's outstanding federal tax liabilities. After the levies were served, an IRS revenue officer informed Daniel that the levies attached both the monthly membership distribution and the 3 percent fee generated from operation of the hotels. The levy forms contained instructions and excerpts of various statutes. After consulting the LLC's attorney, Daniel responded to the IRS that he understood all the tax liabilities of the Weatherses were satisfied and the company did not pay wages or salary to the Weatherses. The IRS revenue officer replied in a letter that the levies attached to all monies paid to the Weathers couple, not just wages and salaries, and Daniel was required to comply with the levies. In April 2008, the IRS sent two final demand for payment forms regarding the notices of levy based on the Weatherses' outstanding tax liabilities. As manager of 911 Management, Daniel continued to make the guaranteed monthly distributions and 3 percent licensing proceeds to Kathy and Thomas until the company dissolved.

The government sued 911 Management and Daniel for the balance of the Weatherses' unpaid tax liabilities for which the levies were issued and for a 50 percent penalty for failure to honor the levies without reasonable cause. The court entered a default judgment against 911 Management for $129, 200 and ruled that Daniel was personally liable for the default judgment amount.

Code Sec. 6332 provides that any person in possession of property or rights to property subject to levy must surrender such property or rights to the IRS upon demand, except such property or rights that are subject to attachment or execution under any judicial process.

OBSERVATION: For purposes of this rule, the term "person," includes an officer or employee of a corporation or a member or employee of a partnership, who is under a duty to surrender the property, or rights to property, or to discharge the obligation.

Daniel argued that the language of the levies was ambiguous, confusing, and contained contrary instructions, and therefore, there was a bona fide dispute over the legal effectiveness of the levies and over the property to be surrendered.

The IRS contended that 911 Management was formed to attempt to provide Kathy with income while Thomas was in prison and that there was no bona fide dispute over the amount of the levied property under Daniel's control or the legal effectiveness of the levies.

A district court held that Daniel established reasonable cause for his failure to honor the 2008 IRS levies. Under the circumstances, including ongoing litigation over the 2007 levies, confusing language in the 2008 notices over whether the levies attached only to funds owed at the time of the levies were issued, and legal counsel's subjective concern that the IRS may have used the wrong levy form, the court found it was objectively reasonable for Daniel to rely on the company legal counsel's direction even though the advice was contrary to the instructions of the IRS revenue officer. Accordingly, Daniel established that there was a bona fide legal dispute over the effectiveness of the 2008 levies on which he relied when he decided to refuse to honor those levies. Therefore, Daniel was not liable for the 50 percent penalty, the court concluded.

For a discussion of IRS levies, see Parker Tax ¶260,540. (Staff Contributor Parker Tax Publishing)

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