New York Loosens Strict LLC Member Liability for Unpaid Sales Taxes
Many states impose personal liability for unpaid sales taxes and income tax withholdings on LLC managers and employees who are responsible for paying the taxes. For example, in an Oregon Tax Court case I recently blogged about, here, a 10% LLC member and non-manager who occasionally signed checks for the LLC was assessed liability for the LLC’s unpaid income tax withholdings by the Department of Revenue. Because he had authority to sign checks only under the direction of the 90% owner and manager, the Tax Court held that he was not personally liable.
New York has long taken a far different, nay draconian, approach.
Like many other states, New York imposes personal liability for payment of unpaid sales taxes on corporate and LLC employees and managers having a duty to the entity to act for it in complying with the sales tax. N.Y. Tax Law §§ 1133, 1131(1). But the New York statute goes further and imposes personal liability on “any member of a partnership or limited liability company” for the LLC’s sales tax obligations. N.Y. Tax Law § 1131(1). It is irrelevant whether the LLC member is a manager or employee – even passive investors are jointly and severally liable for 100% of the LLC’s New York sales tax obligations. (There is no comparable rule for shareholders of a corporation.)
The rule applies to any LLC that is obligated to collect New York sales taxes – it is not limited to LLCs formed under New York law. For example, the members of a Delaware LLC making retail sales in New York would be subject to personal liability for the LLC’s unpaid sales taxes. The New York Department of Taxation has not hesitated to pursue LLC members for sales taxes under the rule, even passive investors.
The Tax Department’s new policy provides partial relief for minority members, i.e., those whose ownership interest and distributive share of the LLC’s profits and losses are less than 50%. Technical Memorandum TSB-M-11(6)S (Apr. 14, 2011). A minority member will now be liable only for its pro rata share of the taxes, i.e., the product of the LLC’s sales tax liability multiplied by the greater of the member’s percentage of ownership interest or its percentage share of the profits and losses of the LLC.
The policy imposes several conditions before a minority member is eligible for relief. The member must document its ownership interest and percentage share of the LLC’s profits and losses, demonstrate that it was not under a duty to act for the LLC in complying with the LLC’s sales tax obligations, and cooperate with the Tax Department in providing information about other potentially responsible persons and about the structure and ownership of tiered entities, including out-of-state entities.
The new policy provides no relief for LLC members owning 50% or more of the LLC, who will each continue to be personally liable for all LLC sales tax obligations. But by reducing the personal liability of minority members to a pro rata share of the LLC’s tax obligations it can dramatically limit a minority member’s exposure.
Member Avoids Personal Liability for LLC's Withheld Taxes
An LLC member ordinarily is not liable for the debts and liabilities of an LLC simply by virtue of being a member. E.g., Wash. Rev. Code § 25.15.125; Or. Rev. Stat. § 63.165. Many states, however, impose personal liability for unpaid taxes on those within a business who have authority for paying taxes withheld from employee wages, or for paying sales taxes collected from customers. If one of those statutes applies, being a member of the LLC will not shield the employee, manager or officer from the statute’s reach.
Kelly Haugen, a 10% member of an Oregon LLC, was assessed liability by the Oregon Department of Revenue for the LLC’s failure to pay Oregon income taxes withheld from employee wages. Haugen v. Dep’t of Revenue, No. TC-MD 100052C, 2011 Ore. Tax LEXIS 187 (Or. T.C. Apr. 26, 2011). The LLC was manager-managed, and Haugen was not the LLC’s manager. Haugen occasionally signed checks for the LLC, and a form filed by the LLC with the state indicated that Haugen was responsible for hiring and firing employees. Id., at *2-3. The Department of Revenue asserted liability against Haugen because of his part ownership of the LLC and because he signed checks for the business. Id. at *6.
Oregon requires employers to withhold and pay Oregon income taxes from wages paid to employees. Or. Rev. Stat. § 316.167. Personal liability for unpaid tax withholdings is imposed on “[a]n officer or employee of a corporation, or a member or employee of a partnership, who as such officer, employee or member is under a duty to perform the acts required of employers by ORS 316.167 ….” Or. Rev. Stat. § 316.162(3)(b).
Finding a paucity of case law on the liability of LLC members, the Haugen court analogized Haugen’s status to that of a corporate officer for the purpose of determining liability. Haugen, 2011 Ore. Tax LEXIS 187, at *6. The court applied prior Oregon case law involving corporate officers, and found that Haugen would be liable if he had the actual authority and control to pay or direct payment of the tax withholdings. Id. at *7. The evidence indicated that Haugen did not have authority to unilaterally sign checks or make important financial decisions – he had authority to sign checks only under the direction of the 90% owner and manager, after obtaining specific consent to sign each check. Also, Haugen did not have general authority as a member, because the LLC was manager-managed, and Haugen was not a manager.
The court concluded that because Haugen “was not in a position to pay the withholdings or direct the payment of the withholdings at the time the duty arose to withhold or pay over the taxes,” he was not an “employer” under Or. Rev. Stat. § 316.162. Haugen, 2011 Ore. Tax LEXIS 187, at *11-12. The court therefore canceled the Department of Revenue’s Notice of Liability against Haugen.
Kelly Haugen escaped liability for the unpaid taxes because of his lack of authority. Had his been a member-managed LLC, or if he had had discretion to sign checks without prior approval, the court presumably would have upheld the tax assessment against him.
Many of the comparable statutes from other states are at least as strict in finding managers and check signers to be personally liable for failure to pay tax withholdings and sales taxes over to the state. The strict approach is not surprising, given that in these cases the business has in effect been a tax collector for the state and (at least in the state’s view) is holding the state’s money. The Haugen case should be a wake-up call for LLC managers and check signers to avoid the temptation of financing the business in troubled times by holding on to tax withholdings or sales taxes.
