Responsible Person Liability for Sales Tax: When the Business Can't Pay, Who Gets Sued?

The Collection Sequence Nobody Explains Until It's Already Running

The Business Gets Hit First

When a business falls behind on taxes, states generally don't go after individuals first. Instead, a business will receive a final notice. The final notice is sent to the business and demands payment on the amount already assessed. This step is typically a last resort before a state records a lien against a business. A lien will attach to a business's real property and personal property, until the debt owed is paid.

New York's Civil Enforcement Division will not serve a bank levy on a business until they have filed a tax warrant. However, once a tax warrant is on record, further collection can move forward without a separate warning. That is New York's specific procedure, but first a notice, then a lien, then more aggressive means of collection is the general pattern across most of the states where we practice collection.

When the State Stops Waiting and Starts Naming Names

In my experience, the state doesn't normally sit down and identify the specific liable individual before beginning collection efforts. More often than not, the state will issue a collection order against the business first, and against any person related to the business. The state may then freeze a business's bank accounts, garnish the business's receivables, or levy funds that are in the reach of the state, before going after the people who are personally liable.

Often, multiple people will be named in the same case. These can include owners and managers, as well as bookkeepers who signed the sales tax returns. These people can be named personally liable for the sales tax within weeks of each other.

Who Actually Qualifies as a Responsible Person, and Why the State Casts a Wide Net

Ownership Percentage Is Not the Test

Ownership percentage does not correlate to personal responsibility. The main concern for the courts is who actually controls the business. This is generally determined by identifying who was authorized to file tax returns, who signed checks, who had access to the business account, who decided which expenses would be paid, and who made decisions on how to allocate the business's limited funds.

California's Revenue and Taxation Code Section 6829 states that officers and managers of a company can only be held personally liable for a company's unpaid sales tax for the time that they physically controlled the money, and only for willful neglect to pay. In Illinois, under 35 ILCS 735, Sec. 3-7, an officer or employee who has control of the duty to file returns or the duty to pay the tax is personally liable for the full amount which was not paid or filed willfully, and in this situation the person on the business card is of less importance than the person controlling the checkbook.

New York's statute takes a broader approach than Illinois's and California's because New York does not require proof of willfulness. California also limits exposure to the time a defendant actually had control, a limitation New York's statute does not provide. Therefore, the same set of facts can result in a narrower outcome in California than in New York.

Why States Flag Everyone and Sort It Out Later

States flag anyone that signed a sales tax return as potentially liable. Resolving that you shouldn't be liable is up to you and occurs after the fact. This is a smart strategy for a state: it costs them nothing to have a wide net, and in the meantime, they have pushed the cost and burden of proof on you to demonstrate you aren't liable.

If you do not own the business and are just signing its returns and are wondering if the exposure applies to you, we have discussed the control test and how a non-owner can disprove responsibility in Responsible Person Liability for Non-Owners. What is provided here is the collection sequence, which applies to all, including those that own the business.

The Defense Most Businesses Never Use: Statute of Limitations and Procedural Missteps

The SOL Defense Most People Don't Know They Have

There are genuine statute of limitations challenges for personal sales tax liability that are underused. A state may have a longer time period to assess a business than to assess the individuals associated with the business, and if the state misses its window to assess the individuals, a bona fide statute of limitations defense will shield the individuals even if the business still has a liability.

These defenses vary by state and the specifics of the case, and the time window for using these defenses is typically short. We discussed the New York-specific mechanisms for notice and appeal involving a named individual separately in our write-up on Responsible Person Liability for New York Sales Tax, as that process requires a more detailed treatment.

When the State Skips Its Own Procedures to Close a Case

This happens a lot in New York, in my experience. I have firsthand seen the state move to close out a collection case without following its own procedures, because in their view closing the case is the most important thing. I have seen that time after time in my practice representing businesses and individuals.

The difference between the procedures the state was required to follow and the actual procedures the state followed can be quite relevant. Failing to follow required procedures could provide the basis to challenge the entire assessment rather than just the amount due.

The Biggest Mistake: Giving the State More Than It Asked For

Less Is More: Why Overproviding Creates Exposure

The biggest blunder businesses make when collection activities begin is supplying too much information. Many businesses believe that full cooperation, giving everything the state may request, will facilitate an immediate resolution or demonstrate good faith. More times than not, this belief is incorrect.

Every record turned over gets scrutinized for what it says, and a record never specifically requested can raise new questions the state never had. This is why the old legal adage, "less is more," is, unfortunately, generally true. Respond to exactly what is requested and let your lawyer review what is going to be produced. This is not advice to withhold any records a business is legally obligated to produce. This is a comment on how records should be produced, and in what order, within the scope of records the state is entitled to produce.

What to Do Before a Notice Has Your Name on It

If your business has received a final notice or a lien has been filed, the process has already begun and the people associated with that business should consider themselves next in line. Do not wait to find out. Your business is probably already insolvent. Find out the status of your business today, not after a bank account is frozen or a notice is served with your name on it.

Our team of lawyers, CPAs and former state auditors recognize and remedy this type of collection exposure for the business and individuals associated with it. The earlier we become involved, the more options we have to work with. Learn more about our responsible person defense work.

FAQ

Is there a difference between a closed business and a personal sales tax obligation?

No. Generally, sales tax is considered a trust fund obligation. This means that the state can pursue the individual that controlled the money, even if the business entity no longer exists. The state can also still make a claim against the entity.

What is the actual order of collection steps a state takes before naming a responsible person?

I've found that the order of steps is typically a final notice to the business, a lien recorded against business assets, freezing of business bank accounts, garnishment or levy of available funds, and only then naming individuals. The order and the timing of steps varies by state, but the general pattern is the same in all of the states where I do collection work.

Can the state freeze my business bank account before I even know there's a problem?

Yes, most states aren't required to provide a separate warning before a freeze. By the time a state freezes a business account, that business has typically received a final notice and a recorded lien, and thus notice has, in some form or another, been provided. Although the freeze may come as a surprise, a lot of work and notices usually happen before the freeze.

Is there a statute of limitations defense to a personal (responsible person) sales tax assessment?

Possibly, depending on the state and the facts. States generally have a separate window to assess an individual personally, and if that window has closed, it can be a defense. This is not always the case and depends on the actual timeline in your case, hence it needs to be checked, as opposed to assumed.

Does signing a sales tax return automatically make me personally liable if the business can't pay?

It depends on the state. In some states, signing a return provides evidence that you are in control, but in some states, such as Illinois and California, willful failure to pay the sales tax is required. However, in New York, willful failure to pay is not required. Therefore, it depends on what state you are in.

Can more than one person be held personally liable for the same unpaid sales tax at the same time?

Yes. A state could hold more than one person liable for unpaid sales tax at the same time. It is common for states to name multiple people connected with the business, including the owners, a manager, and a bookkeeper with signing authority, for unpaid taxes at the same time.

What's the difference between a tax lien, a tax warrant, and a bank levy?

A lien is a legal claim or charge against property in order to satisfy a debt. A tax warrant is a different form of legal process. Tax warrants, or certificates, are solely used in certain states like New York. They are used to give the state permission to collect a delinquent tax through various tax collection remedies. A levy is the state taking funds. Again, in New York a levy is not permissible until a warrant is issued.

If I hand over everything the state asks for during a collection action, does that help or hurt my case?

It probably will hurt more than it will help. Giving the state more information than what is asked for can allow them to discover other issues that they didn't have the basis to ask for, therefore it is better to respond to what is asked rather than what is relevant.

Can the state come after my personal assets if I was only a minority owner or a non-owner employee?

Yes. Most states look at control over the filings and tax payments. A minority owner or even a non-owner employee with signing authority could be named personally.

This article provides general information and is not legal or tax advice. Fact-based determinations of responsible person liability depend on many specifics of the situation and state. Sales tax attorneys can be consulted for legal advice.

About the Author

Gerald J. "Jerry" Donnini II is a sales tax lawyer and founder of Sales Tax Helper. Over the last 15 years, he has represented thousands of businesses in sales tax audits and appeals in over 40 states. During this time, he developed a national practice in sales tax defense and nexus planning. Jerry earned an LLM in Taxation from New York University, and authored a treatise on state sales and use tax for CCH. Jerry has defended hundreds of millions of dollars in sales tax assessments and has saved his clients over $500 million. Jerry's practice focuses on sales tax defense and nexus planning. His approach to defending sales and use tax assessments is Find It. Fix It. Defend It., a full service solution to clients that encompasses nexus determination and planning, voluntary disclosure agreements, and sales tax defense.