Liabilities that are not Limited in Limited Liability Companies
Are members of a limited liability company shielded from being personally responsible for all liabilities arising from the company’s business? No! Are these ways in which these liabilities can be avoided? Of course!
In 1993, Michigan adopted the Michigan Limited Liability Company Act (“MLLCA”) (MCLA § 450.4201, et seq.; MSA § 21.198(4101), et seq). It was designed to give the owners protection from the liabilities of the business enterprise while avoiding the double taxation of income associated with C Corporations and the frailties and rigidness of S Corporations.
A limited liability company has the advantages of traditional partnerships and corporations. It is able to fully utilize the flexibility of partnerships in it designing the business venture to meet the needs of its participants and it has one level of tax at the owner’s level. Yet, it was given the limited liability aspects of corporations. MLLCA provides: Unless otherwise provided by law or in an operating agreement, a person who is a member or manager, or both, of a limited liability company is not liable for the acts, debts or allegations of the limited liability company. MCLA § 450.4501(2).
In most cases, this resolves the issue and gives the relief desired. However, the language is not all inclusive. What liabilities are “otherwise provided by law” as to permit imposition on members and/or managers of limited liability companies?
There are two (2) distinct types of limited liability companies member-managed and manager-managed. The default is member-managed. Each member will be deemed a manager unless the Articles of Organization or Operating Agreement provide otherwise. Managers will be subject to the liabilities discussed below. The objective, therefore, is that if a participant is not going to be involved in the actual management of the business, then the participant should avoid being a member of a member-managed limited liability company. The liabilities borne by managers of a limited liability company might be borne by all members of a member-managed company, even if the member does not actually participate in the management of the business enterprise.
It has been the position of the Michigan Department of Revenue that corporate officers having control over making tax returns or the payment of taxes are personally responsible for Michigan taxes not paid by the corporation. RAB 1989-38. This includes sales tax [MCL § 205.65(2)], use tax [MCL § 205.96(3)], income tax [MCL § 206.357(5)], the motor fuel tax [MCL § 207.127(5)(2)], and penalties and interest.
It is the current position of the Michigan Department of Revenue that all members of a member-managed limited liability company have management control over making tax returns and the payment of taxes. Therefore, all members are personally liable for the payment of Michigan taxes, penalties and interest not paid by the limited liability company. This liability can be avoided by a showing that the member was not a manager and had no power to manage the enterprise. That showing cannot be made in a member-managed company. The limited liability company would have to be a manager-managed entity. If member-managed, the member would be presumed to have the authority and ability to manage the enterprise. The fact of whether that authority was exercised or not would be irrelevant.
Self-employment tax is imposed upon self-employment income in 2002 at 12.4% on the first $84,900, less wages subject to FICA, plus Medicare of 2.9% on everything. Generally, distribution to members of a member-managed limited liability company are treated as self-employment income, except those related to rent, interest and dividend income. Thus, a return on capital invested in inventory, machinery and employees may be subject to payroll taxes just as normal wages would be.
In a manager-managed limited liability company the non-management members could avoid the self-employment tax on distributions.
Federal Withholding of Income and FICA Taxes
Businesses with payroll are required to withhold income taxes and the employee’s portion of FICA and Medicare taxes. The federal government deems these to be TRUST FUND TAXES. Those responsible for withholding and paying these taxes over to the government are held liable personally for these taxes if they are not paid over.
Currently, we have no recorded cases of the Internal Revenue Service imposing personal liability on a member in a member-managed limited liability company without a showing of actual control by the member. That does not mean that the Internal Revenue Service will not or has not done so. It is not a stretch for the federal government to take the same position as the State of Michigan. Caution is recommended.
Limited liability companies shield members and managers from a great deal of liability incurred by the business enterprise. However, unpaid taxes of the business can be imposed upon the managers if they are deemed managers whether, in fact, any management specifically provided otherwise, the members of a limited liability company will be deemed its managers and thereby incur the liabilities of a manager whether the member manages the enterprise or is a passive investor. The roles of the various members should be carefully spelled out in the organizational documentation so these liabilities are not placed where they should not be placed.