By Michel P. Cassier, Mark S. Klein, and Andrew B. Sabol
In Brief
Finding the Responsible Party
Personal liability is an uncomfortable issue, and no one wants to think that it could happen to them. But federal and New York State tax law takes a hard-line approach to corporations that neglect to pay their taxes for whatever reason—including bankruptcy. Officers and employees may be in for a rude awakening when they discover they are personally liable for unpaid taxes or penalties. But the existing case law shows that things are not always what they seem. Although a corporate officer may appear at first glance to be the responsible person, a full analysis of the facts and circumstances may reveal otherwise. In addition, because of different legal standards, a person may be held personally responsible for one tax while escaping liability for another. Understanding the rules up front is entirely preferable to dealing with the consequences later.
Corporations and similar entities, such as limited liability companies, limited liability partnerships, and limited partnerships, provide their principals with some measure of protection from personal liability. While the exact rules vary by entity and jurisdiction, a corporation generally exists independently of the individuals that own, manage, or work for it. The corporation incurs liabilities on its own behalf and interposes a shield between its owners, officers, directors, and employees and the rest of the world.
If the business fails, the corporation generally shields its principals from losing more than their investment in the enterprise.
The exception is when the liabilities in question are unpaid trust fund taxes, which are best described as those taxes collected by a private agent from the actual taxpayer on the government’s behalf. The agent collects these taxes and holds them “in trust” for the government before remitting them to the taxing authority. Such taxes include state and federal withholding taxes, sales and use taxes, the employee portion of FICA, and certain other taxes. Unlike most other corporate obligations, liability for these taxes can extend beyond the corporate entity, and personal liability for their payment can attach to the person or persons responsible for their payment (see IRC sections 6671 and 6672).
Many corporate owners, officers, and managers don’t know that these tax liabilities can affect them directly. While some executives are conceptually aware that they may be held responsible for unpaid taxes, the consequences often remain unexamined until a business is in dire financial straits. There may be simple confusion as to the identity of the “responsible person” within the corporation.
Clarifying the Question
“Who is the responsible person?” is a difficult question to answer in New York because the state’s personal income tax and sales and use tax rules fail to adequately define the term. The question is better phrased, “Who has the duty to act?”
Section 685(g) of New York State’s personal income tax law imposes a penalty equal to the total amount of withholding taxes “willfully” evaded, uncollected, or not accounted for and paid over to the state on the “person required to collect, truthfully account for and pay over the tax.” This provision is virtually identical to IRC section 6672, which imposes penalties for attempting to evade federal income taxes. Employing a slightly different standard, section 1133(a) of the New York State sales tax law provides that “every person” required to collect Article 28 taxes is personally responsible for the tax.
But who is this person? In the pertinent part, New York’s personal income tax law defines this person as the “individual, corporation, partnership or limited liability company or an officer or employee of any corporation (including a dissolved corporation), or a member or employee of any partnership, or a member, manager or employee of a limited liability company, who as such officer, employee, manager or member is under a duty to perform the act in respect of which the violation occurs” (italics added). Section 1131(l) of the New York State tax law provides a similar catch-all definition of “persons required to collect [the sales and use] tax.”
While these provisions put the onus of responsibility on the person under a duty to act, only the sales and use tax regulations give an inkling as to who the state considers this person to be. According to section 526.11(b)(2) of the New York Tax Regulations, this question is to be resolved “in every case on the particular facts involved.” The regulation further states that “[g]enerally, a person who is authorized to sign a corporation’s tax returns or who is responsible for maintaining the corporate books, or who is responsible for the corporation’s management, is under a duty to act.”
While helpful, this language is still vague and fails to address situations where these responsibilities are split between more than one party or shared by a group, or where the deficiency is based on the recharacterization of a nontaxable transaction into a taxable one (such as when independent contractors are recharacterized as employees). These aspects are important, because liability may include not only those taxes actually collected, but also those taxes the agent was obligated to collect but did not.
Relevant Factors
A 1990 New York case, (New York State Division of Tax Appeals, Tax Appeals Tribunal, Sep. 27, 1990), established that identifying the person under a duty to act requires an inquiry into “whether the individual had or could have had sufficient authority and control over the affairs of the business to be considered a responsible officer or employee.” The following factors were found relevant in the sales and use tax area: the individual’s status as an officer, director, or shareholder; the individual’s authorization to write checks on behalf of the corporation; the individual’s knowledge of and control over the financial affairs of the corporation; the individual’s authorization to hire and fire employees; whether the individual signed tax returns for the corporation; and the individual’s economic interests in the corporation. Similar factors have been found relevant in determining whether an individual was required to collect and pay withholding taxes.
This guidance helps narrow the field somewhat, and in some instances the identity of the responsible person will be clear. For example, the majority shareholder and president of a closely held corporation who takes an active role in the day-to-day business of the corporation, signs all checks and tax returns, hires and fires employees, and receives significant compensation will most likely be viewed as possessing a duty to act and be found responsible for collecting and remitting these taxes.
Small changes in the facts, however, lead to unpredictable results. For example, the officer in Matter of Stamas (New York State Division of Tax Appeals, Tax Appeals Tribunal, May 19, 1994) was the president, COO, CFO, and a member of the board of directors of a research and development corporation that had failed to remit its withholding taxes. The Tax Appeals Tribunal determined that Stamas was not a responsible person, even though it determined him to be primarily responsible for the management, operations, and financial affairs of the corporation; he derived substantial income from the corporation; he was a shareholder and investor in the corporation; and he had authority to sign tax returns and checks drawn on the corporate account. The deciding factor was that he had no authority to make any payments without specific authorization and direction from one of two persons; therefore, the tribunal determined that he had insufficient authority to ensure that withholding taxes were paid.
The inquiry does not stop once a person has been deemed a “responsible person.” Depending upon the type of tax at issue, other factors may determine whether the person is ultimately found personally liable for the corporation’s tax liability.
Sales and Use Tax vs. Withholding Tax Liability
The type of tax determines whether the corporation’s penalties and interest will be assessed against the responsible person. Section 1145(e) of the New York State tax law specifically directs that the penalties and interest on the corporation’s unpaid sales and use tax obligations “pass through” to the responsible person. With regard to withholding liabilities, however, the responsible person is not assessed the corporation’s “tax,” but rather a “penalty equal to the total amount of tax evaded, or not collected, or not accounted for and paid over.” Thus, none of the penalties and interest assessed against the corporation are included in the assessment against the responsible person—although interest will soon begin to accrue on the liability.
The above distinction is enormous. The sales and use tax may be assessed only against the responsible person within that period of time specified by the tax law—generally, three years—and may include accrued interest and penalties. On the other hand, the withholding tax penalty does not include the corporation’s accrued interest and penalties, but may be assessed at any time.
In addition to these mechanical rules, the standards of accountability differ from one tax to the next. Section 1133(a) of the New York State tax law provides that every person required to collect sales and use taxes “shall be personally liable for the tax,” in effect imposing a form of strict liability. The withholding tax standard, however, is completely different: Section 685(g) does not impose personal liability upon a responsible person unless the failure to pay the tax is “willful.” Compare the following two cases. Although the petitioners were almost indistinguishable, in each, one was found personally responsible for the tax while the other was not, solely because of the type of tax at issue.
In Matter of Maedl (New York State Division of Tax Appeals, Administrative Law Judge Unit, May 12, 1994), the president and majority shareholder of a software development company was found not to be a person under a duty to collect, account for, and pay withholding taxes because this responsibility had been delegated to a subordinate. Maedl was involved in many aspects of the corporation’s business, and during the audit period his energies were focused on capital acquisition, money management, and research and development. He was the highest-paid employee and owned the largest percentage of shares in the company. On these facts, the administrative law judge determined that Maedl did not willfully withhold the payment of the taxes due because he and the board of directors had directed the secretary/treasurer to pay all required taxes. Maedl’s delegation of responsibility and his belief that the individual was paying the required taxes were viewed as reasonable and he was accordingly found not to be responsible for the unpaid withholding taxes.
The result was different in Matter of Barton (New York State Division of Tax Appeals, Administrative Law Judge Unit, Dec. 18, 1989), even though the facts were essentially the same. As president and director of the assessed corporation, Barton had sole check-writing responsibilities, signed the corporate tax returns, and managed corporate personnel and operations; additionally, he was the corporation’s CFO, owned 40% of the common stock, and hired and fired employees. The administrative law judge determined that Barton was under a duty to act for the corporation and was personally liable for the corporation’s unpaid sales taxes—despite the fact that he had delegated this responsibility. Barton’s delegation of duties was a question of willfulness, and willfulness is not an issue under the statute, which, in effect, establishes “strict liability” for unpaid sales and use taxes.
What About the Corporation?
In most cases, the taxing authority does not need to pursue the corporation before assessing the responsible person. In one example, a corporation’s two owner-officers were found personally liable for the corporation’s sales and use taxes, even though the corporation had assets available from which to pay some of the tax due. The New York Tax Appeals Tribunal determined that the state was not required to first pursue collection efforts against the corporation; furthermore, the existence of corporate assets did not, as a matter of law, prevent the state from assessing and collecting the tax from the responsible persons.
Executives must also remember that responsible person liability will not be absolved by virtue of the corporation’s bankruptcy. New York State case law clearly upholds that a bankruptcy court order dismissing claims for unpaid taxes against a corporation does not preclude an assessment against the responsible person. Nor does personal bankruptcy offer protection, because the bankruptcy law specifically provides that personal liability for trust fund taxes may not be discharged.
Traps for the Wary
The responsible person issue can pop up in unexpected places. In 1995, for example, the New York Tax Appeals Tribunal affirmed an administrative law judge determination that a limited partner, whose involvement was strictly that of a passive investor, could be a responsible person under the sales and use tax law. A 1997 tribunal decision affirmed an opinion which explicitly held that the Tax Law places liability on all members of a partnership, without distinguishing between general and limited partners. Both opinions were subject to qualification, but the tribunal unequivocally agreed with the administrative law judge’s determination of liability in a subsequent matter, leaving little doubt that limited partners may have responsible person sales and use tax liabilities under section 1131 of the New York State tax law, which provides that “any member of a partnership” may be held personally liable for the partnership’s sales and use tax liabilities, regardless of whether that person is under a duty to act on the partnership’s behalf.
Many states have begun taking the initiative by identifying responsible persons during their initial audit of the business. New York now initiates most sales tax audits by asking businesses to complete responsible person questionnaires, which essentially ask potential responsible persons to detail their role in the business. The questionnaire may help pinpoint which individual to assess, but its timing does little to help that individual understand the nature of the potential liabilities. By the time the responsible person sees that form, it is probably too late.
Potential responsible persons should consider the following suggestions to minimize their chances of being saddled with unwanted liability:
While timely completion of these questionnaires helps the department immensely, there appears to be no benefit to the taxpayer. The Tax Department cannot determine any “extra” tax as a result of the corporation’s failure to offer up other parties against whom to collect. Nor can it argue that the entity is required to maintain or provide such records. New York State’s sales and use tax rules require only that taxpayers maintain records adequate to establish the accuracy of their reported tax liabilities. The identification of a responsible person is not necessary to establish the accuracy of a return, and does not appear to be required by law.
If targeted for audit, retain tax counsel with a proven audit defense track record as early as possible. Whether the tax is due at the corporate level may be a substantive issue. There may also be a genuine issue as to whether an individual is actually a responsible person. In a series of cases, the New York Tax Appeals Tribunal has held that officers with apparent authority were not responsible persons when the facts showed that others precluded them from exercising their authority. In one notable case, a petitioner proved that he was not a responsible person—even though he was the controlling stockholder, vice president, and chairman of the board—by establishing that he had been deceived into believing that the company was meeting its sales tax obligations.
Another reason to retain experienced tax counsel is that many general practitioners are unaware of the procedural nuances that can determine the ultimate outcome of an audit. For example, the Tax Appeals Tribunal determined in Matter of Bleistein (New York State Division of Tax Appeals, Tax Appeals Tribunal, Jul. 27, 1995) that a corporate officer’s signature on a consent to extend the time period for issuing a sales and use tax assessment against the corporation did not extend the time period for issuing an assessment against the officer in his individual capacity. The officer escaped personal liability as a result.
Responsibility and Nexus
Within the context of a sales and use tax audit, Bleistein shows that each responsible person is a separate and distinct taxpayer entitled to the full panoply of rights and privileges afforded every other taxpayer, including a separate and distinct statute of limitations on assessment. While this decision has had an immediate impact on New York State’s audit procedure (the Tax Department’s use of responsible person questionnaires) and collection abilities, the long-term question Bleistein raises is: What other rights and privileges does a responsible person enjoy as a separate taxpayer? The most notable open question is the meaning of “nexus” within the Commerce Clause.
Presidents, CFOs, or similar executives of multistate corporations frequently work out of administrative offices located in another state. These executives typically oversee the filing of corporate sales tax returns and are likely to be deemed responsible persons upon audit. If, in connection with this employment, a nonresident responsible person never sets foot in New York, can that individual be held personally liable for New York sales and use taxes?
After Bleistein, it is difficult to see how. Tested at the level of the responsible person—as an individual taxpayer distinct from the corporation—the minimum threshold for nexus under the U.S. Supreme Court decision in Quill Corp. v North Dakota [504 U.S. 298 (1992)] is lacking: The nonresident individual has no contact with New York other than the act of causing a return to be filed. The New York courts do not appear to see this as an involuntarily admission of nexus. In Franklin Mint Corp. v Tully [61 N.Y.2d 980 (1984), aff’g 94 A.D.2d 877 (3rd Dep’t 1983)], a corporate taxpayer that voluntarily registered as a vendor in New York was excused from liability because it did not otherwise have nexus with New York. The mere act of registering and voluntarily submitting returns did not give the state the right under the Commerce Clause to compel compliance with its sales tax law.
Nor can the state argue that an individual responsible person has nexus by virtue of the corporation’s activities in New York. The responsible person’s liability is not “derivative” of the corporation; Bleistein states that it is distinct. And while the principles of agency may dictate that acts performed by corporate officers and employees are ascribed to the corporation, the inverse is certainly not true.
Although untested, this hypothesis should give tax practitioners and nonresident officers who work outside New York food for thought.
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