Under most state tax laws, the tax authority of the state has the option to pursue collection of unpaid sales taxes against any individual who has the authority within a company for the collection and remittance of the tax. These so called “corporate officer liability” statutes have been in existence for many years but, for the most part, were rarely enforced. Most states have re-labeled these statutes as “responsible party” statues to make it clear that owners and others can be personally liable even if they are not officers of the company.
Generally, states use “responsible party” laws to impose personal liability on individuals only if they cannot collect from the company itself. The most frequent cases involve insolvency or dissolution of the company before all sales taxes are paid. With many states now experiencing revenue shortfalls, some state tax authorities are now aggressively pursuing responsible parties when they cannot collect from the company. This issue is also more important today because the Internet has raised some difficult questions on when sales taxes must be collected for Internet sales.
A recent Tax Appeals case in New York demonstrates this problem of responsible-person liability very well. New York Tax Law states that “every person required to collect any [sales] tax imposed by this article shall be personally liable for the tax imposed, collected or required to be collected.” Thus, liability may include not only those taxes actually collected, but also those taxes the company was obligated to collect but did not. In other words, the requirement to remit sales tax applies whether or not the tax was ever collected. Moreover, a responsible party is anyone with a duty to act, not just the person who was assigned the responsibility to remit the taxes.
According to the New York Tax Regulations, this question of “duty to act” 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.” A 1990 New York Tax Appeals case 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.
In the recent New York Tax Appeals case, petitioner was the CEO, a director and a shareholder of a public company. He acknowledged that he was responsible for the day-to-day management of the company but said he relied on the CFO and outside accountants to manage the financial affairs of the company. However, he had access to the company books and records and had the authority to write checks. He also had the authority to hire and fire employees. Based on these facts, he was held to be personally liable for payment of sales taxes owed by the company.
Some Practical Advice
- Make sure that all “trust fund” taxes (sales and use taxes and payroll withholding) are paid when due. This may seem obvious, but a business may end up with a large tax bill, including penalties, simply because it did not realize that a transaction was a taxable event. The danger lies in a tax audit, where the tax authority may recharacterize a transaction or relationship as taxable, and this often occurs in the context of sales and use taxes or withholding taxes. For example, independent contractors may be recharacterized as employees, upon whose wages are due state and federal withholding, FICA, and FUTA.
- Consult with an experienced tax advisor to ensure that all relevant taxes are being collected and remitted properly.
- When entering into a new business venture, determine up front who will be responsible for collecting and remitting taxes. Do so in writing—in a shareholder or partnership agreement, corporate bylaws, or an employment agreement.
- Upon discovering a tax problem, take steps to rectify the problem in order to avoid personal liability and do so while the company is solvent. The worst of all worlds is to ignore the problem, only to find years later that the company does not have enough money to cover past due taxes and penalties.
- If faced with a responsible person questionnaire, give serious thought to how—and whether—to complete it. The tax department may have its eye on the statute of limitations and want to identify potential responsible parties early in the audit before any statute of limitation period expires. Once these people are identified, the department can ask for statutory waivers. (In New York, the three-year statute of limitations for companies does not apply in the determination of the personal liability of responsible parties.)