Under the "check-the-box" Treasury Regulations, an entity that is formed as a limited liability company (an "LLC") in any U.S. state, and that has only one member, by default will generally be disregarded as a separate entity. Thus, as far as the Internal Revenue Code (the "Code") is concerned, the entity does not exist, and all activities performed and incomed earned by such entity are attributed to its sole member (or the first upstream indirect member that is not also a disregarded entity).
However, as one employer recently found out the hard way, there is an exception to this general rule when it comes to employment taxes. In a recent tax court case, DAF Charters, LLC v. Commissioner, 152 T.C. No. 14 (May 9, 2019), the tax court ruled that a U.S.-organized LLC wholly owned by a non-U.S. corporation was an "American employer," and therefore was required to pay employment taxes.
DAF Charters LLC ("DAF") was an LLC organized in the state of Florida that was wholly owned by a Cayman Islands corporation. DAF owned and operated a charter yacht that was registered in the Cayman Islands. DAF employed a crew consisting of U.S. citizens. Believing that it was disregarded for employment tax purposes, DAF did not withhold and pay employment taxes in 2012, and was subsequently assessed and levied upon by the IRS.
The Code's definition of "employment" for employment taxes generally encompasses employment that occurs within the U.S., regardless of the citizenship or residence of the employer or employee, as well as employment that occurs outside of the U.S. if (1) the employee is a U.S. citizen or resident, and (2) the employer is an "American employer."
There is a special rule, the "crewman's exemption," that excludes services from the definition of employment if a) the services are performed in connection with a non-U.S. vessel; b) the employee is employed on such vessel, when outside the U.S.; and c) either the employee is not a U.S. citizen or the employer is not an "American employer."
DAF and the IRS agreed that the first two conditions of the crewman's exemption were met, and that the crew were U.S. citizens, so the application of the crewman's exemption hinged on whether the employer was considered to be an "American employer." DAF asserted that, because it was a disregarded entity under the check-the-box rules, the employer of its crew was DAF's parent, the Cayman Islands corporation, which was clearly not an American employer.
The court, however, pointed to a specific exception in the check-the-box regulations, Treas. Reg. Sec. 301.7701-2(c)(2)(iv)(A) and (B), which provides that a single-member entity that is otherwise treated as disregarded under the check-the-box rules is not disregarded for purposes of employment taxes, and is instead treated as a corporation. This meant that the employer was DAF, which, because it was organized in Florida, met the definition of an "American employer."
Once again, this case demonstrates the importance of a careful reading of the applicable rules.