New York State Sales Tax and the Choice of Business Entity

By Robert S. Barnett

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MAY 2006 - Protection from personal liability is often a large factor in the choice of business entity. Asset protection plays a large role in structuring financial and business affairs. The risks associated with sales tax liabilities are often overlooked, but such liabilities can be avoided.

New York Tax Law section 1133(a) imposes personal liability for unpaid sales and use taxes upon “persons required to collect tax.” In a corporate context, the persons required to collect and remit sales and use taxes include any employed officers, directors, or managers who are under a duty to act for the corporation [see section 1131(1)].

In matters before the New York State Tax Commission involving personal liability for sales and use taxes, the result often turns on an analysis of whether such a person was under a duty to act for the corporation. Merely holding a corporate office does not automatically result in strict liability [see Chevlowe v. Koerner, 407 N.Y.S 2d 427 (1978)]. The inquiry as to whether a person is responsible for collecting and paying sales and use taxes involves a thorough investigation of all the relevant facts and circumstances. The central inquiry is whether the individual had sufficient authority and control over the affairs of the corporation. In such an instance, the person will be considered an officer or employee responsible for payment of the taxes assessed [Matter of Constantino (Tax Appeals Tribune, September 27, 1990)]. The notice of determination issued by the New York State Tax Department is accorded a presumption of correctness [Petition of John P. Bartolomei (NYS Tax Appeals Tribunal TSB-D-96(28S), April 3, 1997)]. Therefore, the burden of proof rests heavily upon taxpayers to present sufficient support and confirmation regarding their responsibilities.

Determining Factors

The New York State Tax Commission considers various factors in making the determination as to whether an individual should be held personally liable for the sales and use tax imposed. They include:

  • The individual’s corporate status as a director or officer;
  • The individual’s status as a shareholder, and the percentage of shares owned;
  • The individual’s participation in formal or informal shareholders’ meetings, directors’ meetings, and other corporate formalities;
  • The individual’s participation in corporate accounting and bookkeeping functions;
  • The individual’s knowledge of, and control over, the financial affairs of the corporation;
  • The individual’s authorization within the corporation to perform management functions, such as employee hiring and firing;
  • Whether the individual controlled the actions of others or was controlled by others;
  • Whether the individual signed tax returns and met with accountants;
  • Prior assessments against the corporation, and its history of delinquency;
  • Involvement in the day-to-day business operations; and
  • Whether the individual was authorized as a check signatory.

It is important for legal counsel to develop a detailed working knowledge of how the corporate affairs were handled and how any other factors might assist in the evaluation. Because the burden of proof to overcome a sales tax assessment rests with the taxpayer, it is important to obtain third-party confirmation of the factual results. Such evidence must show that the individual did not possess sufficient knowledge, control, or discretion over business affairs.

The importance of the above analysis is to show that a corporate officer, shareholder, or director is not per se personally liable under Tax Law section 1131(1). The tax law does, however, impose per se or strict personal liability on “any member of a partnership or limited liability company.” This personal liability is imposed regardless of such partner’s or member’s percentage of ownership and involvement in the operation and management of the organization. The statute will include any member of a partnership or limited liability company (LLC), even if the member has no involvement in the management of the company. Regarding Bartolomei, the Tax Appeals Tribunal affirmed the statutory imposition of strict liability on a limited partner or LLC member. A New York State Conciliation Conference Hearing Officer, in a recent conversation with this author regarding the statute and Albany’s current position regarding enforcement, stated that her instructions are to interpret the statute according to its plain language and to apply strict liability. It is unclear whether interposing an inactive S corporation as a partner or member (instead of individual membership) would absolve a nonactive member from liability through the corporate analysis previously described.

Choose the Form of Business Carefully

Professional advisors should consider sales tax implications when evaluating business entity considerations. The corporate form of organization should be considered to protect a minority or inactive shareholder. Noncontrolling shareholders should take steps to avoid personal sales tax liability. As long as a shareholder lacks the requisite discretion and authority over corporate transactions, he will not incur personal liability.

Proving the level of corporate control and discretion possessed by an individual shareholder is often difficult. The inquiry is often raised by the New York State Tax Department at a time when shareholders are on unfriendly terms and documents are not readily available. A copy of bank records can prove that an individual is not an authorized account signatory. Additionally, the shareholder agreement can confirm the degree of responsibility levels and authority for corporate officers. Indemnity agreements may also be useful to more fully protect inactive shareholders or investors.


Robert S. Barnett, CPA, JD, MST, is a partner in Capell Barnett Matalon & Schoenfeld LLP, Jericho, N.Y.


 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



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