Can the IRS or NYS Hold You Liable for Business Taxes?

If you own or manage a business, you might assume that you’re immune to any legal or financial liabilities of your business. This is generally true, but there are exceptions – in particular, certain individuals can be held personally liable for business taxes. Personal liability can apply to the tax itself as well as certain penalties that may accompany it, such as the Trust Fund Recovery Penalty.

This article explores these scenarios and offers guidance on what you can do to prevent personal liability. For additional help, the tax professionals from McLaud Law P.C. are ready to assist you and your business.

This article explores these scenarios and offers guidance on what you can do to prevent personal liability. For additional help, the tax professionals from McLaud Law P.C. are ready to assist you and your business.

Key Takeaways

• Trust fund taxes are taxes that businesses collect and pay on behalf of another person, like income taxes that are withheld from employees’ pay, and sales taxes.
• The IRS or the NYS DTF can hold people personally liable for unpaid trust fund taxes if they’re deemed “responsible” for the nonpayment.
• A person is responsible if they knew or should have known about the trust fund tax obligation, had the power to ensure it was collected and paid, but took intentional steps that prevented the collection and/or payment.
• The best way to avoid personal liability for unpaid trust fund taxes is to be proactive about their collection and payment, which includes consulting with a business tax professional, such as a trust fund tax attorney.

Personal Liability for Business Taxes

Limited liability is one of the biggest reasons why business structures such as corporations, limited liability companies (LLCs), and limited liability partnerships (LLPs) exist. These structures create a distinction between the business and its owners, and they generally ensure that the owners aren’t liable for the business’s debts or liabilities.

This is based on the idea that separating the liability of a company from its employees, owners, and/or managers benefits society as a whole. Specifically, it encourages entrepreneurship and investment by limiting the personal risk of owners and investors.

However, courts will sometimes hold individuals liable when there’s a compelling public policy reason for doing so, such as if the owners used their limited liability to try to get away with fraud. Another reason is when trust fund taxes are involved.

What Are Trust Fund Taxes?

The two most common types are payroll taxes and sales taxes. These are considered trust fund taxes because they’re collected by a business or employer from the employee or consumer on behalf of a government taxing authority, like the Internal Revenue Service (IRS) or New York State (NYS) Department of Taxation and Finance (DTF).

• Payroll trust fund taxes – Taxes withheld from an employee’s pay and sent to the IRS or state. This does not include the employer match for FICA taxes or any other taxes paid by the employer.
• Sales tax – Taxes collected from customers when they purchase taxable goods or services. Then, the business sends the sales tax to the government.

Because the business or employer is collecting, holding, and remitting the taxes owed by the employee or consumer, these taxes are considered to be held in trust. The IRS and NYS DTF consider violations of this “trust” to be among the most serious of tax violations. Therefore, these agencies are willing to impose personal liability on those responsible for nonpayment of trust fund taxes.

Is failure to pay trust fund taxes a crime?

In some cases, individual criminal liability is possible. For instance, under New York law, a responsible individual of a business faces the possibility of jail time and/or monetary fines if they:

• Willfully fail to collect sales tax (Tax Law Section 1801(a)(6)).
• Willfully fail to pay the sales tax collected (Tax Law Section 1801(a)(5)).
• Willfully fail to pay any tax (Tax Law Section 1801(a)(7)).

As scary as the idea of going to jail is, most trust fund tax issues don’t result in criminal charges. In the majority of cases, personal liability for the unpaid payroll or sales taxes is the most severe sanction a responsible person can expect.

Who Is a Responsible Person for Personal Liability Purposes?

The answer depends on whether we’re talking about federal or New York trust fund taxes. If the former, the issue is whether or not a person is liable for the Trust Fund Recovery Penalty, or TFRP. If the latter, the issue is whether an individual qualifies for a Responsible Person Assessment, or RPA.

The IRS TFRP

If the IRS is unable to quickly collect unpaid trust fund taxes from the business itself, the IRS may impose the TFRP on an individual if the following two conditions exist:

1. The individual is responsible for the collection and payment of withheld employment and income taxes to the IRS.
2. The individual willfully chooses not to collect or pay the taxes.

A person is considered to be “responsible” if they have the duty and ability to collect and pay the trust fund taxes. This often includes owners and managers, but can occasionally include regular employees, such as bookkeepers.

A person is deemed to have acted “willfully” if they were aware of the non-collection or nonpayment of trust fund taxes (or should have been aware) and purposely ignored the law, or recklessly disregarded its requirements.

An important thing to note about the willfulness requirement is that bad faith isn’t necessary. For example, the decision to pay employees or other expenses instead of trust fund taxes is deemed to be a willful act within the TFRP context. If the IRS believes you’re responsible, they’ll send Letter 1153.

The NYS DTF Responsible Person Assessment

Under Tax Law Section 1133, owners, officers, directors, managers, employees, and other responsible individuals can be personally liable for unpaid sales and use taxes. Generally speaking, the NYS DTF will issue a Responsible Person Assessment (RPA) if they believe an individual had enough control and authority over the business’s operations. If this assessment is not successfully disputed, then they would be personally liable for the unpaid trust fund taxes.

To decide if a person has sufficient control and authority, several factors will be considered, including the person’s:

• Job title and/or status within the organization.
• Level of knowledge over the organization’s financial affairs.
• Ability to write checks on behalf of the organization.
• Duties, if any, to maintain the accounting records of the organization.
• Authority to hire or fire employees.
• Level of economic interest in the organization.

If more than one person is deemed responsible, then joint and several liability applies. If a person wants to challenge the RPA, the burden is on them to prove with clear and convincing evidence that they aren’t responsible and therefore, aren’t liable for the unpaid trust fund taxes.

Tax Enforcement by the IRS or NYS Department of Taxation and Finance

Once the decision is made to hold someone personally liable for unpaid trust fund taxes, that person’s assets are at risk of being subject to tax collection efforts, such as liens, warrants, and levies.