In Part I of this article, the question was asked whether a federal tax lien encumbers property owned by an LLC in which the taxpayer who owes federal income tax owns a membership interest.
As a general rule, the tax lien only encumbers property of the taxpayer. Therefore, the federal tax lien in the name of the individual taxpayer would not encumber the property held in the LLC. However, the IRS has ways it can reach the assets in the LLC. Among those ways are reverse veil piercing and charging orders. These are analyzed under Montana law for purposes of this article.
Reverse Veil Piercing. Essentially, by invoking “reverse veil piercing”, the IRS would be asking a court to disregard the LLC’s separate and distinct legal status and use its assets to satisfy the owner/member’s individual tax liability.
However, reverse veil piercing has not been extensively litigated. Where it has been litigated, it has been met with scepticism by many courts and therefore has received inconsistent treatment. Furthermore, there does not appear to be any clear precedent in Montana for “outsider” reverse veil piercing (claims by outside parties, as opposed to claims by members/shareholders, known as “insider” reverse veil piercing). (see Moats Trucking Co., Inc. v. Gallatin Dairies, Inc., 753 P.2d 883 (1988) (with respect to “insider reverse veil piercing”, holding that sole shareholders of a corporation were not entitled to bring an action for emotional distress on behalf of themselves arising out of an alleged breach of contract because the corporation was the real party in interest and the corporation could not experience emotional distress); see also Stott v. Fox, 246 Mont. 301 (1990) and First Sec. Bank of Glendive v. Gary, 798 P.2d 523 (1990) (both disallowing insider reverse veil piercing claims by corporate shareholders)).
Thus, it is unclear whether the IRS could bring an action under reverse veil piercing, though it could certainly try.
In a similar manner, the IRS could attempt to reach the assets of the LLC under legal doctrines of nominee liens and fraudulent transfers in evasion of creditors. These legal doctrines are not discussed in this article
Charging Order. It is possible (and perhaps likely) that the taxpayer’s ownership/distributional interest in the LLC would fall within the definition of personal property subject to a federal tax lien. Mont. Code Ann. § 35-8-703(2) notes that “a member’s distributional interest in a limited liability company is personal property…” (emphasis added).
Because federal tax liens attach to a taxpayer’s real and personal property, this could make the taxpayer’s ownership/distributional interest in the LLC subject to a charging order in favor of the IRS pursuant to Mont. Code Ann. § 35-8-705(1) (2019), which provides that “on application to a court of competent jurisdiction by any judgment creditor of a member, the court may charge the distributional interest of the member with payment of the unsatisfied amount of judgment, with interest.” In other words, “a charging order constitutes a lien on the judgment debtor’s distributional interest…”, which would allow the court to “order a foreclosure of a lien on a distributional interest subject to the charging order at any time.” Mont. Code Ann. § 35-8-705(3).
Thus, the IRS would be entitled to the taxpayer’s distributions under a charging order. While the federal tax lien will not encumber the property of the LLC since that property is owned by the LLC and not by the taxpayer who owes the federal tax debt, the IRS is not powerless to go after the LLC assets. The IRS may attempt reverse veil piercing, a charging order, or other legal methods to obtain the taxpayer’s interest in the LLC.
I encourage a taxpayer with outstanding tax liability to contact a tax professional to discuss collection and lien issues, including how a tax lien may impact property owned by LLCs.
Jared M. Le Fevre is a Partner in the Tax, Trusts and Estates Practice Group of Crowley Fleck PLLP. Mr. Le Fevre represents taxpayers before the IRS, IRS Independent Office of Appeals, Tax Court, Federal District Court and state tax agencies throughout Montana, Wyoming, North Dakota, Idaho, and Utah. Mr. Le Fevre is involved in federal and state and local tax audits, appeals, and tax resolution throughout these western states. Mr. Le Fevre also advises clients on the tax effects of business and real estate transactions.