“Personal liability?!” the client screams. “For sales tax? How is that possible?” The look on their face is at once incredulous and accusatory. “Didn’t you say that the LLC would protect me and my assets from the liabilities of the business so long as we respected ‘corporate’ formalities, and treated the LLC as a separate entity? I’m not even involved in its day-to-day operation and management – I’m just a ‘big-picture’ guy, a passive investor.”
The client’s confusion is understandable. Most investors do not realize that a member of an LLC may be held personally liable by N.Y. State for any sales tax required to be collected and remitted by the LLC, even when the “LLC veil” has not been pierced, and even when the member does not participate in the LLC’s business.
The rationale for this per se personal liability lies in the “trust fund” nature of the sales tax.
The Sales Tax
In general, the sales tax is a transaction tax, with the liability for the tax arising at the time of the transaction. It is also a “consumer tax” in that 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 as a trustee for, and on account of, the State. The tax is imposed on the purchase of a taxable good or service, but it is collected from the buyer by the seller, and then held by the seller in trust for the State, until the seller remits the tax to the State.
The State’s Tax Law imposes personal responsibility for the collection and remittance of the sales tax on an LLC’s so-called “responsible persons,” which may include certain employees or managers, as well as the members, of the LLC. More than one person may be treated as a responsible person.
A responsible person is jointly and severally liable for all of the sales tax owed, along with the LLC and any of the LLC’s other responsible persons. This means that the responsible person’s personal assets could be taken by the State to satisfy the entire sales tax liability of the business. Members of an LLC can be held personally responsible even though they are otherwise protected from the business liabilities of the LLC.
Personal liability attaches whether or not the tax imposed was collected. In other words, it is not limited to tax that has been collected but has not been remitted. Thus, it will also apply where a business might have had a sales tax collection obligation, but was unaware of it.
Along the same lines, the personal liability applies even where the individual’s failure to take responsibility for collecting and/or remitting the sales tax was not willful.
In addition, the penalties and interest on the corporation’s unpaid sales tax pass through to the responsible person.
In general, the Tax Law provides that every member of an LLC is a “person required to collect” any sales tax for which the LLC is responsible; thus, a member is per se liable for the LLC’s unpaid sales tax, plus interest and penalties, without regard to their role or degree of involvement in the LLC’s business.
Beginning in 2011, however, the State’s Department of Taxation and Finance provided some relief from the per se personal liability for certain LLC members.
Specifically, a qualifying member would not be personally liable for any penalties relating to the LLC’s unpaid sales taxes, and their liability for such taxes would be limited to their pro rata share thereof.
In order to qualify for this relief, a member of an LLC had to document that their ownership interest in, and distributive share of the profits and losses of, the LLC were each less than 50%. They also had to demonstrate that they were not “under a duty to act” on behalf of the LLC – for example, because of their management position – in complying with the sales tax.
In addition, the member had to agree to such terms and conditions as the State may require in exchange for such relief, including cooperation with the State by providing information regarding the identities of other potentially responsible persons—particularly those persons involved in the day-to-day affairs of the business.
It is important to note that any member of an LLC that held a 50% or more ownership interest in the LLC, or that was entitled to a distributive share of 50% or more of the profits and losses of the LLC, was not eligible for this relief.
2018-2019 Fiscal Year Budget
A variation on this administratively-provided relief was recently codified by the State as part of its 2018-2019 Fiscal Year Budget.
Under the new law, a member of an LLC continues to be treated as a “person required to collect” sales tax. Thus, membership by itself remains a sufficient reason for imposing personal liability on a member for the LLC’s unpaid sales tax.
Application for Relief
However, the new law also provides that the State may grant a member relief from such personal liability if the member applies for relief, and demonstrates that (i) their percentage ownership interest, and their percentage distributive share of profits and losses, of the LLC are each less than 50%, and (ii) they were not under a duty to act for the LLC in complying with the sales tax.
If the State approves a member’s application for relief, the member’s liability will be limited to that percentage of the LLC’s sales tax liability that reflects the member’s ownership interest or distributive share, whichever percentage is higher, plus any interest accrued thereon; the member will not be liable for any penalty owed by the LLC.
It is unlikely that more LLC members will find relief under the 2018-2019 Budget provision than under the administrative relief program it replaced.
Members with an LLC ownership interest or distributive share of at least 50% will continue to be out of luck in avoiding personal liability, notwithstanding the level of their “disengagement” from the business of the LLC – there will continue to be an effective presumption that such a member could have acted to ensure compliance with the sales tax law.
This “presumption” was illustrated in a recent ALJ decision. Taxpayer and his partner each owned 50% on an LLC. According to Taxpayer, his partner was the general manager of the business and oversaw all the daily activities of the business, including, among other things, hiring, firing and supervising employees, and purchasing supplies. Taxpayer testified that his health prevented him from being actively involved in the business.
At some point, LLC began having issues paying its bills, and its vendors began pursuing collection from LLC, Taxpayer and his partner.
The State performed a sales tax audit of LLC, which resulted in the assertion of a sales tax deficiency, which LLC agreed to satisfy pursuant to a payment plan. Unfortunately, LLC failed to make any of the scheduled payments, and the State issued a notice and demand for payment of tax due.
The auditor determined that Taxpayer was a responsible person for LLC and, consequently, the State issued a notice of determination to Taxpayer assessing the sales and use taxes due from LLC.
Taxpayer agreed that LLC owed owes sales taxes, and did not challenge the underlying audit amount. However, he asserted that he was not a responsible person during the audit periods. Taxpayer asserted that he could not take an active role in managing LLC because of his health. He further asserted that the other 50% owner was the general manager of the business and the responsible person during the audit periods.
Taxpayer might as well have been speaking to the wall.
The ALJ explained that, under the Tax Law, “every person required to collect the sales tax shall be personally liable for the tax imposed, collected or required to be collected.”
The Tax Law, the ALJ continued, defines “person required to collect” sales tax to include: “any employee or manager of [an LLC] . . . who as such . . . employee or manager is under a duty to act for such . . . [LLC] . . . in complying with [the sales tax law]; and any member of a . . . limited liability company.”
The ALJ emphasized that the law “clearly states that any member of [an LLC] is a ‘person required to collect’ [the sales tax]” and, furthermore, that a member of an LLC “shall be personally liable for the [sales] tax imposed, collected or required to be collected.”
The ALJ also pointed out that the Tax Law contains no factors to qualify or limit the liability imposed upon members of an LLC. “[Taxpayer] was a member of [an LLC] and . . . , such members are subject to per se liability for the taxes due from the [LLC]. . . . Since [the Tax Law] imposes strict liability upon members of . . . [an LLC], all that is required to be shown by the [State] for liability to obtain is the person’s status as a member.”
Because Taxpayer was a 50% member of LLC during the audit periods, the ALJ concluded that he was per se personally liable for the sales taxes due; moreover, he was not eligible for the administrative relief afforded under the 2011 program described above.
Ah, the fate of a 50% member.
But what about a “less-than-50%,” or minority, member who was unable to secure any voice in the management of the business from the other member(s) of the LLC (for example, executive employment or a position on its board)? Such a member may be able to demonstrate that they were not “under a duty to act” in connection with sales tax matters and, so, they should be able to avoid personal liability for the LLC’s unpaid sales taxes.
That may provide some comfort to a minority member, who may not be in a position to compel or influence decision-making, and thereby enjoy the economic benefits of membership, including the distribution of profits, or the sale of the business, and who, for the same reasons, was unable to extract any contractual indemnity obligation from the controlling member of the LLC.
As in so many instances involving the application of the tax laws, there seems to be a direct relationship here between the ability to control one’s investment in a business, on the one hand, and one’s exposure for the tax liability of the business, on the other. Decisions, decisions.