A couple of weeks ago, we considered a situation in which an unscrupulous partner (perhaps in cahoots with an IRS agent) tried to stick one of their partners with the federal employment taxes owed by their failing business. This week, we encounter a somewhat similar situation involving the imposition of personal liability on an innocent employee for a corporation’s N.Y. sales taxes.
Personal Liability for Sales Tax?
Many taxpayers fail to appreciate that, under certain circumstances, a shareholder, officer, director or employee of a corporation may be held personally liable for the sales tax collected or required to be collected by the entity.
In general, the sales tax is a transaction tax, with the liability for the tax arising at the time of the transaction. The person required to collect the tax – the seller – must collect it from the buyer when collecting the sales price for the transaction to which the tax applies.
The seller collects the tax for and on account of the State, then holds it in trust for the State until the seller remits the tax to the State.
In the case where the seller is a corporation, N.Y. State imposes personal responsibility for payment of the sales tax on certain shareholders, officers, directors, or employees (“responsible persons”) of the corporation. More than one person may be treated as a responsible person.
A responsible person is jointly and severally liable for the tax owed, along with the corporation and any other responsible persons. This means that the responsible person’s personal assets may be taken by the State to satisfy the sales tax liability of the corporation (the corporate “shield” is ignored).
Personal liability attaches whether or not the tax imposed was collected by the corporation – it is not limited to tax that has been collected but has not been remitted. The personal liability applies even where the individual’s failure to take responsibility for collecting and/or remitting the sales tax was not willful.
Moreover, the personal liability of a responsible person for sales tax is separate and distinct from that of the business – it extends beyond the corporation. For example, a corporate bankruptcy does not affect the responsible person’s liability for the tax because the latter involves a separate claim than the one that is asserted against the corporation.
The Responsible Person
Every officer or employee of a corporation who is under a duty to act for the corporation in complying with any requirement of the N.Y. sales tax law is a responsible person required to collect, truthfully account for, and pay over the sales tax.
Holding a corporate office or being a shareholder does not, in and of itself, warrant the imposition of personal liability. Only those who were “under a duty to act” on behalf of the corporation may be assessed the tax, with the main inquiry being whether the individual in question had sufficient authority and control over the affairs of the corporation.
Whether such officer or employee is a responsible person is to be determined in every case on the basis of particular facts involved. Generally, 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. However, it is actual, rather than titular, control that counts.
Fact or Fiction?
A recent decision considered whether an individual who was both an officer and a shareholder of a corporation may be held responsible for the corporation’s sales tax liability where he was precluded from taking action with regard to the financial and management activities of the corporation, and whether the significance of his officer and shareholder status may be offset by the circumstances relating to control of the corporation.
Taxpayer was an employee of Corp X during the audit period. During the same period, he was the president and sole shareholder of Corp Y, a separate purchasing company that was effectively operated by Corp X.
During the audit period, Taxpayer signed several sales tax returns as president of Corp Y and was listed as the sole shareholder of Corp Y on its N.Y. “S” corporation tax return.
Corp Y filed the sales tax returns but did not remit the tax due.
N.Y. issued to Corp Y notices and demands for payment of the tax due. The corporation was also assessed penalties and interest.
N.Y. also issued notices to Taxpayer, arguing that the facts in evidence justified holding him liable for the sales taxes due from Corp Y: he was an officer and shareholder who signed checks and corporate documents for Corp Y.
In response, Taxpayer argued that he was “young and naïve” when Corp Y was “put in his name.” He was not aware of what his boss, Mr. X, had done. (It should be noted that, by the time of the audit, Mr. X had died.) He did not contribute any capital to the business. He was being used without knowing or understanding what was being done in his name. The sales and taxes generated were as a result of his recently deceased boss’s efforts.
In short, Taxpayer claimed that he was not a person responsible for the collection and payment of sales tax on behalf of Corp Y.
The matter was then presented to an administrative law judge, where the question to be resolved was whether Taxpayer had or could have had sufficient authority and control over the affairs of Corp Y to be considered a responsible officer or employee.
Here Comes the Judge
N.Y. imposes upon any person required to collect sales tax personal liability for the tax imposed, collected or required to be collected. A person required to collect tax is defined to include, among others, corporate officers and employees who are under a duty to act for such corporation in complying with the requirements of the sales tax law.
According to the Court, the determination of whether an individual is a person under a duty to act for a business is based upon a close examination of the particular facts of the case. Among the factors to be considered were the following: whether Taxpayer was authorized to sign corporate tax returns; was responsible for managing or maintaining the corporate books; was permitted to generally manage the corporation; was an officer, director, or shareholder; was authorized to write checks on behalf of the corporation; had knowledge of and control over the financial affairs of the corporation; was authorized to hire and fire employees; and had an economic interest in the corporation.
The Court determined that Taxpayer was not an individual who had or could have had sufficient authority and control over the affairs of the corporation to be considered a responsible officer or employee for Corp Y.
There was no dispute that Taxpayer signed checks, tax returns and corporate documents for Corp Y, or that he was the sole shareholder, as listed on the Corp Y S corporation tax return. However, he never received a salary or any remuneration or distribution from Corp Y. The real question, the Court stated, was whether Taxpayer, as a young man with no business background or education, had any meaningful control of the affairs of the corporation.
Taxpayer credibly testified that he was under the direction and control of Mr. X in all his dealings with Corp Y. He was directed to sign checks and other corporate and tax documents at Mr. X’s direction. All the business operations of Corp Y were handled by Mr. X’s personal assistant and bookkeeper. These facts were buttressed by the testimony of others who worked at Corp X at the same time, who credibly testified that Taxpayer was hired by Corp X to conduct mundane and routine tasks, and that Mr. X controlled both Corp X and Corp Y and made all decisions for both. He did not delegate duties to his employees. Everything was done on his direction.
On the basis of the foregoing, the Court found that Taxpayer was not in a position to have any kind of meaningful control over the business, and it determined that he was not responsible for the sales tax due on behalf of Corp Y.
Know Your “Partners”
Now, you may be thinking, “why two posts in three weeks on the dire tax consequences that may befall someone who goes into business with an unscrupulous partner?”
The answer is simple: to stress the importance of a business person’s knowing his partner – his finances, experience, reputation, personality, etc. – before going into business with him.
Even after conducting a due diligence review, it will behoove the business person to memorialize the relationship with the new partner in a written agreement, such as a shareholders’ agreement, that covers, among other things, the allocation of duties between them, decision-making procedures, distributions, buyouts, etc. Yes, it will cost more upfront, but it will help to avoid more expensive surprises down the road, especially if the business is not going well.