Alabama Department Of Revenue Seeks To Hold LLC Members Individually Liable For Withholding Tax Not Remitted By LLC

May 2010
Jeff Patterson

If you are a member of a limited liability company (“LLC”), or are considering becoming one, be aware that the Alabama Department of Revenue considers LLC members to be individually liable for taxes that are not paid or remitted by the LLC (except for business privilege tax). Recently, the Department entered an assessment against an LLC and its individual members for income tax that had been withheld by the LLC on its employees, but not remitted. Nonna Rose Kingsley, LLC, and its Members v. Alabama Department of Revenue, Administrative Law Division, # W. 09-1194 (Final Order April 15, 2010). One of the members appealed the assessment to the Department’s Administrative Law Division, arguing that he, being only a member of the LLC, should not be held personally liable for the tax. Id.

The LLC member, a doctor, was asked by certain individuals to finance a new restaurant in Birmingham. The other individuals agreed to operate the restaurant, which was owned and operated through an LLC.

After the restaurant went out of business, the Department entered a tax assessment against the LLC and its members for unremitted withholding tax, plus penalties and interest. The LLC member appealed, and the Department’s Administrative Law Judge (“ALJ”) ruled that members of an LLC are not individually liable for non-income taxes owed by the LLC. In so ruling, the ALJ repeated his opinion from Capitol Machine & Equipment Co. LLC and its Members v. Alabama Department of Revenue, Administrative Law Division, # S. 08-619 (Final Order April 20, 2009; Final Order on Rehearing June 9, 2009).

In Capitol Machine, which was a sales tax case, the primary issue was whether certain pneumatic insulation blowing machines qualified for the reduced machine rate of 1½% on the sales of those machines to industrial contractors, who used the machines to blow loose-fill and wet-spray insulation. A secondary issue was whether the individual members of the LLC were liable for any underpaid sales tax. The ALJ ruled that the machines qualified for the reduced sales-tax rate, because the machines “process” compacted insulation into its intended final use. Because Capitol Machine had charged the reduced machine rate in its sales of the machines, there was no underpayment of sales tax. The ALJ also ruled that members of an LLC are not individually liable for non-income taxes, because Ala. Code § 10-12-20(a) provides that members are not personally liable for the debts of an LLC. The ALJ noted, however, that LLC members still could be held liable for the 100% “responsible person” penalty in Ala. Code §§ 40-29-72 and -73.

The Department applied for rehearing in Capitol Machine, arguing that the ALJ’s ruling on the machine-rate issue caused a ruling on the individual-liability issue to be unnecessary. The ALJ agreed, and issued an order on rehearing that omitted the discussion of the individual liability of LLC members.

Soon afterwards, however, Nonna Rose presented the ALJ with the same question as to individual liability of LLC members, except as to withholding tax. The Department has appealed the ruling in Nonna Rose to the Jefferson County Circuit Court (# CV 2010-901445). If the Department prevails, then the state of the law concerning the limited liability of LLC members will surprise many who believed that the tax obligations of the LLC were just that – obligations of the LLC and not of the members.

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