Foreign-Owned Charter Yacht Not Off the Hook for Employment Taxes

(Parker Tax Publishing May 2019)

In a case of first impression, the Tax Court held that a limited liability company (LLC) which operated a chartered yacht and was organized in Florida and wholly owned by a Cayman Islands corporation was liable for U.S. federal employment taxes on the wages it paid its U.S.-citizen crewmen. The Tax Court found that the LLC was not entitled to the crewmen's exemption of Code Sec. 3121(b)(4), under which wages paid by a foreign employer to U.S. crewmen serving on a foreign vessel when the vessel is outside the United States are not subject to employment taxes, because, for employment tax purposes, an LLC organized in Florida is an "American employer." DAF Charters, LLC v. Comm'r, 152 T.C. No. 14 (2019).

Background

DAF Charters, LLC (DAF), is a limited liability company (LLC) organized in Florida whose sole member is a corporation, DAF Charters, Ltd., a Cayman Islands corporation. When DAF was formed in 2011, its sole member and manager was John Staluppi, a U.S. citizen. Staluppi transferred his membership interest to DAF Charters, Ltd., in 2012, but remained DAF's manager. During 2012, DAF owned and operated a charter yacht that traveled in and out of the United States and its territorial waters. The yacht was registered in the Cayman Islands in January 2012, before which it was registered in the United States. DAF employed crewmen for the yacht, all of whom were U.S. citizens.

DAF filed a Form 941, Employer's Quarterly Federal Tax Return, for the last quarter of 2012, on which it claimed that the wages it paid to its crewmen were exempt from employment taxes under Code Sec. 3121(b)(4). The IRS sent DAF a Notice CP102 advising that changes had been made to its Form 941 resulting in tax due of $6,872 plus interest. DAF filed an amended Form 941 seeking abatement of the assessment on the grounds that it was entitled to the "crewmen's exemption" of Code Sec. 3121(b)(4), under which wages paid by a foreign employer to U.S. crewmen serving on a foreign vessel are not subject to employment taxes when the vessel is outside the United States. The IRS denied DAF's claim, and DAF filed a protest with the IRS Office of Appeals.

While DAF's protest was pending, the IRS sent DAF a Letter 1058, Final Notice of Intent to Levy and Notice of Your Right to a Hearing. In response, DAF submitted Form 12153, Request for a Collection Due Process or Equivalent Hearing (CDP hearing request). DAF's hearing request did not state that it was seeking any collection alternatives. Instead, it asserted that it was challenging the underlying liability on the grounds that it was entitled to the crewmen's exemption and noted that its protest of the denial of its abatement claim remained pending with Appeals.

In a 2014 CDP hearing, DAF reiterated that it was challenging the underlying liability and was not seeking a collection alternative. The Appeals officer sustained the denial of DAF's abatement claim on the basis that it did not qualify for the crewmen's exemption because DAF, a single-member LLC organized in Florida, was regarded as an entity and treated as a corporation for employment tax purposes and thus met the definition of "American employer" under Code Sec. 3121(h). An IRS settlement officer determined that the proposed levy should be sustained and, in August of 2014, Appeals sent DAF a Notice of Determination Concerning Collection Action(s) Under Section 6320 and/or 6330 to that effect (notice of determination). DAF took its case to the Tax Court.

The crewmen's exception under Code Sec. 3121(b)(4) does not apply if the employer is an "American employer." An American employer is defined in Code Sec. 3121(h)(5) in part as "a corporation organized under the laws of the United States or of any State." DAF contended that because its sole owner was a foreign corporation, it could not logically be an American employer. DAF pointed out that Code Sec. 3121(h)(3) and Code Sec. 3121(h)(4), which apply to partnerships and trusts, impose tests based on the residence(s) of the entity's owner(s) and argued that such a residence test should also apply under Code Sec. 3121(h)(5). DAF said that without a residence test, Code Sec. 3121(h)(5) would lead to illogical results. DAF suggested that it would not be an American employer if it were owned half by a U.S. resident (e.g., Staluppi) and half by a foreign entity (e.g., DAF Charters, Ltd.), because in that case it would be treated as a partnership under the check-the-box rules. Yet without a residence test, DAF said, it would be considered an American employer despite being fully foreign owned.

Analysis

The Tax Court held that DAF was an American employer and was thus not entitled to the crewmen's exemption. The court reasoned that, as a single-owner LLC, DAF was automatically treated as a disregarded entity for most federal tax purposes, but for employment tax purposes, that default classification did not apply. Rather, under Reg. Sec. 301.7701-2(c)(2)(i), DAF was treated as a corporation with respect to employment taxes. Because it was undisputed that DAF was organized in Florida, it was therefore an American employer under Code Sec. 3121(h), the court found.

The Tax Court rejected DAF's proposed residence test, noting its absence from the plain language of the statute. The court also reasoned that there was a good reason to apply a residence test for partnerships and trusts and not for corporations. Corporations are generally organized under the laws of some jurisdiction, the court pointed out, but partnerships can exist at common law or simply in fact as an ongoing enterprise with multiple interested parties and no explicit legal form. In the court's view, it was reasonable to presume Congress determined that, for Code Sec. 3121(h), the most relevant and accurate basis on which to judge a corporation is its legal nexus, while for partnerships and trusts it is their owners' residential nexuses. The court was not persuaded by DAF's argument that the court's reading of Code Sec. 3121(h) would lead to illogical results, reasoning that DAF had broad latitude to choose its entity form under the check-the-box rules and now had to live with the tax consequences of its decision.

With respect to DAF's challenge to the proposed levy, the court noted that DAF failed to raise any issues other than its underlying liability and stated several times that it did not wish to pursue any collection alternatives. The court concluded that it was not an abuse of discretion for an Appeals officer to sustain a collection action and not consider collection alternatives when the taxpayer has proposed none.

For a discussion of the definition of employment for FICA tax purposes, see Parker Tax ¶213,140. For a discussion of IRS levies, see Parker Tax ¶260,540.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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