One of the main benefits to utilizing a corporation or LLC for a business is to protect the individuals who own the entity from personal liability for any debts owed by the business. While operating a business under the veil of a corporation or LLC is a wise practice, there are certain situations where the risk of personal liability for debts incurred by the entity is possible. This is commonly referred to as “piercing the corporate veil.” One of the most common situations where an individual can be personally assessed for tax debt incurred by a business entity is when the business fails to pay any required trust fund taxes such as sales tax or the employee’s portion of payroll taxes. In other words, a trust fund tax is any tax that is collected on behalf of someone else and is being held “in trust” for that person or entity.
In New York State, sales tax is collected by vendors on behalf of NYS and held in trust until it is reported and paid to NYS together with the filing of sales tax returns. When sales tax is not collected, reported, or paid as required by law, not only does the business become liable for the sales tax, but any individual who is responsible for or who is otherwise under a duty to collect, account for or pay over the sales tax can be held liable as well. Under certain circumstances, such as in the case of a sole proprietorship, a partnership, or LLC, partners or members can be held responsible for unpaid sales tax even if they were not under a duty to act for the business. Not only can the owner(s) of the business be held responsible for unpaid sales tax, but those employed by the business to assist with sales tax obligations can be held liable as well. As a prime example, if the Controller/Accountant of a business is directed to or makes an independent decision to pay another creditor instead of paying sales tax, he/she can be held liable for the unpaid sales tax.
In the case of an unincorporated business, Limited Partnership (LP) or an LLC that is a disregarded entity for tax purposes, personal liability for the tax debt is automatically attributed to the owners, partners, or members of the business. In the case of a corporation, a formal Responsible Person Assessment (RPA) process is required to hold an individual responsible for unpaid sales tax. When the NYS Department of Taxation and Finance (DTF) issues a sales tax RPA, it issues a Notice of Determination which provides the individual a 90-day opportunity to dispute the RPA determination by requesting a conciliation conference or petitioning for a Division of Tax Appeals hearing. If an RPA is not timely disputed, the RPA becomes fixed and final, which then allows the DTF to pursue all collection methods available against the assets of the responsible person(s). It is particularly important that an appeal be made appropriately and timely within the 90-day deadline if a Notice of Determination for RPA is issued, because if a timely appeal to the RPA is not made, the options to later reverse the RPA determination are limited.
At the federal level (i.e., the IRS), the most common trust fund tax for which personal liability can be asserted, is the employees’ portion of payroll taxes. When a business pays employees, it is required to withhold federal income, social security, and Medicare taxes from the employees’ wages (i.e., the employees’ portion of payroll taxes) and is also required to pay a certain percentage of social security, Medicare, and unemployment taxes for each employee (i.e., the employer’s portion of payroll taxes). Any business that falls behind on the payment of payroll taxes will be responsible for both the employees’ portion and employer’s portion of payroll taxes. At some point thereafter, it is likely that the IRS will assert a Trust Fund Recovery Penalty (TFRP) against any person or persons it determines to be responsible for the failure to pay the employees’ portion of the taxes.
Not only are the owners of the business a potential target for the TFRP, but anyone who the IRS believes is involved in the payment of payroll taxes for the business can be a target. TFRP assessment makes the individual jointly and severally liable for the employees’ portion of the federal withholding taxes.
Before the IRS asserts personal liability for the TFRP it normally conducts what is known in the tax practitioner community as a “4180 Interview” of the person(s) who the IRS suspects are responsible for nonpayment of the payroll tax obligations for the business in question. Also, the IRS normally issues a summons for bank account information to determine who had bank signature authority and who wrote checks to creditors. For the individual(s) who the IRS is seeking a “4180 interview,” how a TFRP interview should be handled involves several legal decisions that are best evaluated by a tax lawyer.
Regardless of whether it is federal or state, when trust fund taxes go unpaid, not only is there civil risk of personal liability but the criminal risk increases exponentially. In NYS, when someone collects sales tax but does not timely pay it over, it is considered larceny. Similarly with the IRS, non-payment of TFRP can be considered a crime as the federal criminal statute for nonpayment of TFRP is strikingly similar to the civil statute for nonpayment of TFRP.
If you or anyone you know is delinquent with their trust fund taxes, it would be a wise decision to hire a competent tax resolution professional who is skilled and experienced in handling civil and criminal tax matters like McLaud Law P.C. Serving Rochester, Webster, Greece and Irondequoit NY.