Denial
It wouldn’t be far-fetched to say that, as a species, we humans have a propensity – rooted in our instinctive tendency for self-preservation – toward denying anything we believe may cause us harm. It should come as no surprise that this natural inclination has found expression in the arts. For example, there are certain lyrics and movie scripts that include lines that are memorable only because they recall this defense mechanism called “denial.”
For example, the artist known as Shaggy[i] created a song around two[ii] simple words with which countless children and former children have responded to a variety of accusatory questions: “Wasn’t me.”
In “Shrek 2,”[iii] following Puss’s arrest and the seizure of the catnip[iv] found in his pocket, the felonious feline immediately declaims “that’s not mine.”
Then there is the famous scene from the first Austin Powers movie[v] – a cinematic tour de force – in which the heroically flawed, orthodontically challenged protagonist, thawed after thirty years of having been cryogenically frozen, collects his personal property:
Quartermaster Clerk: One Swedish-made @#$.
Austin Powers: [to Vanessa[vi]] That’s not mine.
Quartermaster Clerk: One credit card receipt for Swedish-made @#$ signed by Austin Powers.
Austin Powers: I’m telling ya baby, that’s not mine.
Quartermaster Clerk: One warranty card for Swedish-made @#$, filled out by Austin Powers.
Austin Powers: I don’t even know what this is! This sort of thing ain’t my bag, baby.
Quartermaster Clerk: One book, “Swedish-made @#$ And Me: This Sort of Thing Is My Bag Baby”, by Austin Powers.
To these gems we may now add the testimony of the taxpayer in the decision[vii] discussed below, in which New York’s Division of Tax Appeals considered whether Taxpayer was personally liable for the sales tax was owing from Business LLC for the period running from June 2016 through November 2019 (the “Audit Period”).
The Audit
Business LLC operated a business that made sales during the Audit Period that were subject to sales tax. Business LLC was required to file sales tax returns on a quarterly basis, at which time it was required to remit the sales tax collected.
Unfortunately, Business LLC failed to timely file sales tax returns and pay the sales tax due for the Audit Period. Thus, the Division determined that Business LLC had outstanding sales tax liabilities for the Audit Period.
Business LLC was registered in New York as a sales tax vendor during the audit period. Its application for registration, dated 2016, identified Taxpayer as a member of the LLC with a 45 percent ownership interest and described him as a “responsible person” of the business. Furthermore, the application stated that Taxpayer had the authority to sign checks and prepare tax returns on behalf of Business LLC. It listed Taxpayer’s primary duties as tax manager or general manager for Business LLC.
In fact, Taxpayer was a signatory on Business LLC’s account with Bank during the Audit Period. Taxpayer’s signature appeared on the following documents, which the Division received from Bank in response to a subpoena:
- Business overdraft protection form for Business LLC, dated 2016. The form was signed by Taxpayer as an authorized signer of Business LLC and indicated that Taxpayer’s identification was verified by a Bank employee.
- MasterCard business/organizational debit card application for Business LLC, dated 2016. Taxpayer signed the debit card application as an owner or corporate officer of Business LLC. The debit card application listed Taxpayer’s social security number, date of birth and driver’s license information, and indicated that Taxpayer’s identification was verified by Bank.
- Limited Liability Company authorization resolution for Business LLC, dated 2016. The resolution listed Taxpayer as a manager of the LLC and was signed by him as such.
- Business account agreement and backup withholding certification for Business LLC, dated 2016.
Also included with the documents was a “limited liability checklist” signed by a Bank employee indicating that the managing members and authorized signers for Business LLC had provided their names, addresses, and social security numbers.
Taxpayer was listed as the organizer of Business LLC on its articles of organization filed with the New York Department of State in 2016.
A notice from the Internal Revenue Service, dated 2016, assigning an employer identification number for Business LLC, was addressed to Taxpayer as a member of the LLC.
Based on the foregoing, the Division determined that Taxpayer was a responsible person for the sales tax liabilities of Business LLC for the period at issue and issued notices of determination (each dated 2020) to Taxpayer as an officer/responsible person of Business LLC, on which the Division asserted the amount of tax owing, as well as interest and penalties.
Shortly after receiving these notices, Taxpayer filed a certificate of dissolution for Business LLC with the New York Department of State.
Taxpayer’s Tale of Denial
Taxpayer testified that he did not sign the Bank Mastercard business/organizational debit card application or resolution. “Wasn’t me.”
Taxpayer further testified that although his name and social security number appeared on Business LLC’s application for registration as a sales tax vendor, the address listed was not his. “That’s not mine.”
The Division introduced into the record Taxpayer’s IRS form 1095-C, Employer-Provided Health Insurance Offer and Coverage, showing the same address for Taxpayer as that listed on Business LLC’s application for registration as a sales tax vendor.
Taxpayer testified that the business was opened “fictitiously” under his name. “This sort of thing ain’t my bag, baby.”
He testified that he lived with his girlfriend, Frau Farbissina,[viii] for three years and speculated that she may have taken his identification. However, when Taxpayer was later asked what years he lived with Frau Farbissina, he testified that, “I don’t know if it was years . . . No, I don’t know. I have to go back and look. I’d say around 2016.”
Interestingly, Taxpayer did not file a police report regarding the alleged identity theft of his personal information for Business LLC.
And even though the record in the matter was held open until early 2022 to allow Taxpayer to submit additional documents, Taxpayer produced only a copy of his driver’s license – the signature on which appeared to be the same as on Taxpayer’s petition, and the documents from Bank – and various certificates apparently relating to assumed names under which Business LLC had been operated, but which did not support Taxpayer’s position as they fell outside of the Audit Period.
Statutory Interlude
In general, the sales tax is a transaction tax, with the liability for the tax arising at the time of the transaction. It is also a “consumer tax” in that the person required to collect the tax – the seller – must collect it from the buyer when collecting the sales price for the transaction to which the tax applies.
The seller collects the tax as a trustee for, and on account of, the state. The tax is imposed on the purchase of a taxable good or service, but it is collected from the buyer by the seller, and then held by the seller in trust for the state, until the seller remits the tax to the state.
Responsible Persons
New York’s Tax Law imposes personal responsibility for the collection and remittance of the sales tax on an LLC’s so-called “responsible persons,” which may include certain employees or managers, as well as the members, of the LLC. More than one person may be treated as a responsible person.
A responsible person is jointly and severally liable for all of the sales tax owed, along with the LLC and any of the LLC’s other responsible persons. This means that the responsible person’s personal assets could be taken by the State to satisfy the entire sales tax liability of the business. Members of an LLC can be held personally responsible even though they are otherwise protected from the business liabilities of the LLC.
Personal liability attaches whether or not the tax imposed was collected. In other words, it is not limited to tax that has been collected but has not been remitted. Thus, it will also apply where a business might have had a sales tax collection obligation but was unaware of it.
Along the same lines, the personal liability applies even where the individual’s failure to take responsibility for collecting and/or remitting the sales tax was not willful.
In addition, the penalties and interest on the corporation’s unpaid sales tax pass through to the responsible person.
Administrative Relief
In general, the Tax Law used to provide[ix] that every member of an LLC was a “person required to collect” any sales tax for which the LLC was responsible; thus, a member was per se liable for the LLC’s unpaid sales tax, plus interest and penalties, without regard to their role or degree of involvement in the LLC’s business.
Beginning in 2011, however, New York’s Department of Taxation and Finance provided some relief from the per se personal liability for certain LLC members.
Specifically, a qualifying member would not be personally liable for any penalties relating to the LLC’s unpaid sales taxes, and their liability for such taxes would be limited to their pro rata share thereof.
In order to qualify for this relief, a member of an LLC had to document that their ownership interest in, and distributive share of the profits and losses of, the LLC were each less than 50 percent. They also had to demonstrate that they were not “under a duty to act” on behalf of the LLC[x] in complying with the sales tax.
In addition, the member had to agree to such terms and conditions as the State may have required in exchange for such relief.[xi]
It is important to note that any member of an LLC that held a 50 percent or more ownership interest in the LLC, or that was entitled to a distributive share of 50 percent or more of the profits and losses of the LLC, was not eligible for this relief.
2018-2019 Fiscal Year Budget
A variation on this administratively provided relief was codified as part of New York’s 2018-2019 Fiscal Year Budget, became effective April 12, 2018, and remains in effect today.
Under the amended law,[xii] a member of an LLC continues to be treated as a “person required to collect” sales tax. Thus, membership by itself remains a sufficient reason for imposing personal liability on a member for the LLC’s unpaid sales tax.
Application for Relief
However, the new law also provides that the state may grant a member relief from such personal liability if the member applies for relief and demonstrates that (i) their percentage ownership interest, and their percentage distributive share of profits and losses, of the LLC are each less than 50 percent, and (ii) the member was not under a duty to act for the LLC in complying with the sales tax.[xiii]
If the state approves an LLC member’s application for relief, the member’s liability will be limited to that percentage of the LLC’s sales tax liability that reflects the member’s ownership interest or distributive share, whichever percentage is higher, plus any interest accrued thereon; the member will not be liable for any penalty owed by the LLC.
50% or More Member
A member with an LLC ownership interest or distributive share of at least 50 percent continues to be out of luck in avoiding personal liability,[xiv] notwithstanding the level of their “disengagement” from the business of the LLC – there will continue to be an effective presumption that such a member could have acted to ensure compliance with the sales tax law.
Taxpayer’s Personal Liability?
During the Audit Period, through April 11, 2018, the Tax Law contained no factors to qualify or limit the liability imposed upon members of partnerships or limited liability companies and imposed per se liability upon such members.
Thus, for that portion of the Audit Period at issue, if Taxpayer was a member of Business LLC, he was strictly liable for the sales tax liabilities of the LLC.
For that portion of the Audit period at issue from April 12, 2018 to November 30, 2019, the Tax Law provided for qualified relief, if Taxpayer had submitted an application for such relief and provided the required information.
The Court’s Analysis
Taxpayer had the burden of proof to overcome the presumed correctness of the Division’s assessment. According to the Court, upon review of the record, it was clear that Taxpayer did not meet this burden and was properly held responsible for Business LLC’s failure to comply with the sales tax law.
Although Taxpayer alleged that someone else “fictitiously” opened the business using his identification, the Court found that his testimony lacked credibility.
Specifically, although Taxpayer denied that he signed the documents with Bank on behalf of Business LLC – the “wasn’t me” defense – the documents presented by the Division, which were obtained by subpoena issued to Bank, showed that a Bank employee had verified Taxpayer’s identity when he signed the documents.
Additionally, the Court continued, the signature on the Bank documents, Taxpayer’s driver’s license, and the petition signed by Taxpayer matched in appearance and Taxpayer presented no evidence other than self-serving testimony to dispute this (the “that’s not mine” defense).
Furthermore, Taxpayer presented inconsistent testimony when he speculated that perhaps Frau Farbissina had used his identification (the “ain’t my bag” defense), first stating that they lived together for three years, but later stating that it was only around 2016.
Taxpayer’s testimony that the address appearing on the business’s application for sales tax vendor was not his (another version of the “that’s not mine” defense) was also contradicted by his form 1095-C, filed with the Division, showing the same address for Taxpayer.
Taxpayer was listed as the organizer of Business LLC on the articles of organization filed with the Department of State and he admitted that he dissolved the LLC.
Finally, the Court observed that it seemed incredible that such alleged identity theft would not have been reported to the police.
Having determined that Taxpayer failed to meet his burden of proving that he was not a member of Business LLC, the Court found that for the period June 1, 2016 through April 11, 2018 – before the above-described amendment of the Tax Law – Taxpayer was personally liable for the taxes imposed upon Business LLC merely by virtue of his status as a member of the LLC.
Although for the period April 12, 2018 to November 30, 2019, the Tax Law provided for certain qualified relief to liability where a taxpayer applied for such relief to the Division and satisfied certain requirements set forth in the Tax Law, Taxpayer made no showing that he filed such application with the Division or that he met these requirements. Thus, Taxpayer was also personally liable for the taxes imposed upon Business LLC by virtue of his status as a member of the LLC for the period April 12, 2018 to November 30, 2019 and did not qualify for relief.
Oh Well
There is no question that Taxpayer was a responsible person as to Business LLC. But what about another “less-than-50 percent” member who is unable to secure any voice in the management of the business from the other member or members of the LLC?[xv] Such a member may be able to demonstrate that they were not “under a duty to act” in connection with sales tax matters and, so, they should be able, at least in theory, to avoid personal liability for the LLC’s unpaid sales taxes.
That may provide some comfort to a minority member, who may not be in a position to influence decision-making, and thereby enjoy the economic benefits of membership; for example, they cannot compel the distribution of profits, the liquidation of their interest, or the sale of the business, they cannot extract any contractual indemnity obligation from the controlling member of the LLC, and they cannot appoint themselves to a position in the LLC for which they may be paid compensation.[xvi]
As in so many instances involving the application of the tax laws, there seems to be a direct relationship here between the ability to control one’s investment in a business, on the one hand, and one’s exposure for the tax liability of the business, on the other. Decisions, decisions.
The opinions expressed herein are solely those of the author(s) and do not necessarily represent the views of the Firm.
[i] I don’t care to know why.
[ii] OK. Technically, one is a contraction.
[iii] Not as good as the first.
[iv] Sometimes referred to as feline cannabis.
[v] “The Spy Who Shagged Me” (1999).
[vi] Actually, revealed as a Femme-Bot in the second installment of the trilogy. Who would have suspected?
[vii] In re James Patterson, New York Division of Tax Appeals, DTA NO. 829906.
[viii] An attack and defense specialist, and the founder of “the militant wing of the Salvation Army.”
[ix] Former Sec. 1133(a).
[x] For example, someone holding a management position.
[xi] Including cooperation with the State by providing information regarding the identities of other potentially responsible persons, particularly those persons involved in the day-to-day affairs of the business.
[xii] Sec. 1131(1).
It includes, among others: “any officer, director or employee of a corporation or of a dissolved corporation, any employee of a partnership, any employee or manager of a limited liability company, or any employee of an individual proprietorship who as such officer, director, employee or manager is under a duty to act for such corporation, partnership, limited liability company or individual proprietorship in complying with any requirement of this article, or has so acted; and any member of a partnership or limited liability company.”
[xiii] Tax Law Sec. 1133(a).
[xiv] Thus, two equal members are out of luck, as is the majority member (if any).
As I wrote this, I couldn’t help thinking about Yogi Berra. “Baseball is 90 per cent mental. The other half is physical.”
[xv] For example, executive employment or a position on its board.
[xvi] Guaranteed payments under IRC Sec. 707(c).
