A Basic Overview of Personal Liability for Sales and Withholding Taxes
By: The Attorneys of Tenenbaum Law, P.C.
As published in Nassau Lawyer, Journal of the Nassau County Bar Association, 50 Nassau Lawyer 8 (April 2001).
Your client, an officer of a corporation, has been notified by New York State that he is personally liable for taxes that the corporation failed to pay. The numbers are quite high, since interest has been added and continues to accrue. How did he get into this mess, and is there any way you can get him out of it?
Fortunately, you may have the opportunity to challenge these assessments. We will not here discuss the procedural aspects or timeliness of such a contest. This article, however, provides an overview of some of the grounds on which such assessments may be based, and thus contested.
Most likely, your client has been determined by New York State to be a responsible person for trust taxes. The question now turns chiefly on whether your client is in fact a “responsible person.” As seen below, a corporate officer is not necessarily responsible in the legal sense.
The analysis begins with defining the term “trust taxes”. Those most often at issue are sales and use taxes and withholding taxes. Sales taxes that must be collected (whether or not actually collected) are considered to be held in a trust for the State; hence the term “trust taxes”. New York Tax Law Section 1133(a) provides that personal liability attaches to a person required to collect sales tax.
With respect to withholding taxes, employers have the responsibility, under Section 671 of the Tax Law, to deduct from their employees’ wages a sum equal to what the employees ought to pay in income tax. This tax is deemed paid by the employees, even if the employer never forwarded it to the taxing authority. Any amount of tax deducted and withheld is regarded as a special fund in trust for the State. Section 685(g) of the Tax Law provides that a responsible person is liable for a penalty in an amount equal to the tax not paid.
The purpose of these trust tax laws is to ensure collection of tax by holding the responsible individual personally liable, if the business entity does not pay the appropriate amount.
Sales and use taxes
Who is responsible in the eyes of the law? For sales and use taxes, personal liability for a corporation’s unpaid taxes attaches specifically to any officer, director or employee of a corporation (whether the corporation is existing or dissolved) who is under a duty to assure compliance with the relevant tax law. Liability also attaches to any employee of a partnership, limited liability company or individual proprietorship with such a duty; and any member of a partnership or of a limited liability company. See Section 1131(1) of the Tax Law.
The issue of responsibility is a factual question in each case. The question, basically, is the extent of an individual’s actual or potential authority and control over the affairs of the entity.
Sales and use taxes: Criteria considered in determining responsibility
The case law and decisions have identified a variety of factors as indicia of responsibility, including, inter alia, the responsibility and involvement of the individual in the financial affairs and management of the corporation; the authority to direct the expenditure of corporate funds; the ability to sign checks on behalf of the company (although often cited, this factor is not determinative); the actual signing of tax returns; the authority to hire and fire employees; the authority and ability to inspect the corporate books and records; and whether the individual had a financial interest in the company. See, e.g., Matter of Cohen v. State Tax Comm., 128 AD2d 1022, 513 NYS2d 564 (3d Dept. 1987).
In sum, then, a person is responsible if he has the duty or authority to pay trust taxes on behalf of the corporation. The crucial element is control of finances, in particular the authority to direct or participate in decisions regarding the payment of creditors, including the general disbursement of funds.
Practice Tip: If a person does not have authority to handle certain financial affairs, that limitation should be outlined in an employment agreement, resolution or other document, in order to protect such individual.
There is an important caveat relating to the individual who wants to leave the business. An executive can not avoid responsibility by simply moving away or ceasing to be involved in the business on a daily basis. This may be considered merely a refusal to exercise responsibility, rather than the absence of obligation. Practice Tip: The departing executive should write a specific resignation letter, and ensure that his name is removed from the bank signature cards.
An individual may assert that it was in fact someone else’s obligation to pay the taxes concerned. Nevertheless, it is well established that, for purposes of assessment, there may be more than one “responsible person” in a given entity.
Sales and use taxes: Statute of limitations
In addition to proving that an individual is a responsible person for the payment of taxes, the State must meet procedural aspects of the claim as well. Specifically, the State must assess the unpaid taxes within the requisite statutory time period; generally, three years from the date the return was filed.
An interesting situation arises where a consent to extend the statute of limitations has been executed on behalf of a corporation. Such a consent does not automatically extend the limitations period with respect to an individual officer of the corporation who has been personally assessed; even if that officer was the person who actually signed on behalf of the corporation. Matter of Bleistein, (NY Tax Appeals Tribunal, July 27, 1995). Practice Tip: Always check carefully the time periods involved and verify whether there is a statute of limitations issue.
Regarding withholding tax, like sales and use taxes, the first issue is to determine whether the particular individual is personally responsible for trust taxes arising from a shortfall in the payment of withholding taxes. See Tax Law Section 685(n). In fact, the indicia of responsibility for both sales tax and withholding tax are virtually the same. See, e.g., Matter of Wolfstitch v. NYS Tax Commn., 106 AD2d 745, 483 NYS2d 779 (3d Dept. 1984); Matter of McHugh v. NYS Tax Commn., 70 AD2d 987, 417 NYS2d 799 (3d Dept. 1979); Matter of Frenette, (NY Division of Tax Appeals (ALJ), June 22, 2000).
Unlike the standards for the payment of sales tax, however, a person must be more than responsible; he must also have acted willfully in failing to pay the withholding tax. The test is whether the individual consciously and voluntarily acted, knowing that the government would not receive its money, and that the money would be used for other purposes. Willfulness is more than simply a mistake, although the individual does not have to show a deliberate intent to avoid giving the government its money.
Withholding tax: Statute of limitations
The State must assess the entity within the statutory period, which is generally three years from the date the return was filed. In many circumstances, the return is deemed to be filed on April 15 of the succeeding year.
Different statute of limitations rules apply with respect to individuals. The penalty assessed against an individual is distinct from any assessment against the corporation, and a separate statutory liability. Thus, the imposition of this penalty against an individual does not have to be made within the general three year statute of limitations period for the assessment of taxes. See Wolfstitch, supra; Matter of Halpern, (NY Tax Appeals Tribunal, April 9, 1998).
Although an assessment for personal liability is a matter for concern, a knowledge of its grounds may provide a basis for challenge. This article has highlighted only a few of the issues that may be raised. Other substantive and procedural aspects should be considered, for example whether there is reasonable cause for nonpayment of the taxes due, or whether the underlying amounts are correct. Thus, with full exploration of the unique facts and circumstances involved, you can evaluate the “mess” your client is in, and may yet find a way to resolve it to his satisfaction.