NY Needs the Revenue
A couple of weeks ago, the Tax Foundation released its latest “State Business Tax Climate Index,”[i] which assesses a state’s tax system and compares it to that of other states. New York seems to be a perennial among the ten lowest-ranked states, at number 49.[ii]
According to another report recently issued by the Foundation, New York experienced the highest net loss of residents as a result of interstate migration as a share of its population.[iii]
Earlier this month, the Office of the State Comptroller estimated that the State’s tax revenues will decline by 8.4 percent, or $9.4 billion, in FY 2023-24 from the previous year.[iv]
Under the foregoing circumstances, the State will likely pursue tax audits – including with respect to sales taxes – with even more determination than usual to make up as much of the shortfall as possible.
Where appropriate, the State’s examination of the sales tax liability of a business may lead to the collection of such tax from the individual owners of the business, as illustrated by a recent decision that is described below.[v]
But first, a brief description of the sales tax.
The Sales Tax
In general, the sales tax is a transaction tax, with the liability for the tax arising at the time of the transaction; specifically, the tax is imposed on the purchase of a taxable good or service.
At that point, the seller collects the tax from the buyer when collecting the sales price for the transaction to which the tax applies. The seller collects and holds the tax as “trustee” for and on account of the State until the seller remits the tax to the State.
All sales are generally deemed taxable until the contrary is established. The burden of proving that any sale is not taxable is upon the seller and the buyer. In all cases, the parties to the sale transaction must maintain records sufficient to verify all sales tax-related aspects of the transaction, including any exemptions claimed.
With these basics under our belt, let’s turn to the decision.
The Division of Taxation (Division) conducted a sales tax audit of Business LLC for the audit period and determined that Business LLC owed the State additional sales tax.
As part of the audit, the Division determined that individual Taxpayer was a responsible person of Business LLC.
The Division issued a notice of determination asserting Taxpayer’s personal liability for sales tax, plus interest and penalty, as a responsible person for the sales taxes due from Business LLC for the audit period.
Taxpayer filed a request for conciliation conference with the Division’s Bureau of Conciliation and Mediation Services (BCMS) in protest of the notice of determination. Following a conciliation conference, BCMS issued a conciliation order sustaining the notice of determination.
Taxpayer then filed a petition challenging the conciliation order. Notably, Taxpayer did not dispute the dollar amount and calculations set forth in the notice. Furthermore, Taxpayer did not challenge that Business LLC owed the sales tax at issue.
Taxpayer objected only to the determination that he was a responsible person with respect to Business LLC’s sales tax liabilities.
Taxpayer filed a motion to dismiss the claim for per se personal liability.
In support of this motion, Taxpayer’s representative submitted a memorandum of law to which were attached “true and accurate” copies of the federal Schedule K-1s issued by Business LLC over several years that included the audit period. Each Schedule K-1 indicated that ownership of Business LLC was split evenly between Second LLC and Third LLC; not Taxpayer.
Taxpayer’s representative asserted that the Schedule K-1s established that Taxpayer was not a member of Business LLC during the audit period and, therefore, could not be per se liable for the LLC’s sales tax liability.
In further support of his position, Taxpayer submitted:
“(i) the affidavit of the representative who was engaged by Business LLC to represent it in the sales tax audit, in which the representative asserted that Taxpayer was not a member of Business LLC and that the Division erroneously assessed Taxpayer as a responsible person of Business LLC because there were no supporting documents for the Division’s conclusion;
(ii) the affidavit of the individual who served as general manager of Business LLC during a portion of the audit period, affirming that he was in charge of the business operations, management, and financial affairs of the entity, and during that time Taxpayer was not an owner or manager of Business LLC, Taxpayer’s involvement with Business LLC was limited to providing construction work for the entity, and Taxpayer did not receive a salary from Business LLC or write checks or otherwise manage the entity;
(iii) the affidavit of a second individual who served as an assistant manager of Business LLC during a portion of the audit period, in which she affirmed that during that time she worked with the general manager and assisted with the management of Business LLC, Taxpayer was not involved with the management of the LLC, and Taxpayer’s work for Business LLC was limited to construction work; and
(iv) a copy of Business LLC’s Schedule K-1s for the audit period that reflected persons other than Taxpayer as the owners of Business LLC.
On the strength of the foregoing, Taxpayer asserted that he could not be held liable as a responsible party under the Tax Law because he was not a member of Business LLC and the above-referenced managers’ affidavits established that he did not manage the entity.
In support of its position, the Division submitted the affidavit of its auditor, who averred that the Division determined Taxpayer was a responsible person for Business LLC based upon the following evidence, which Taxpayer himself had provided to the Division:
“(i) a consent to an extension of time for the audit of Business LLC, signed by Taxpayer as “investor” (consent);[vi]
(ii) a sales tax examination questionnaire for Business LLC, signed by another person but identifying Taxpayer as a “managing member” of Business LLC; and
(iii) an application to register for a sales tax certificate of authority,[vii] signed by another person but identifying Taxpayer as one of two responsible persons of Business LLC.
On the basis of this evidence, the Division asserted that Taxpayer was effectively a managing member of Business LLC and ,therefore, was liable for Business LLC’s associated sales taxes.
The Division also asserted that Taxpayer failed to meet his burden of proof to establish that he was not a responsible person for Business LLC.
The question before the Court was whether Taxpayer was personally liable for the sales taxes due on behalf of Business LLC as a person required to collect and pay such taxes under the Tax Law.
During the audit period, the Tax Law provided, in part, that: “every person required to collect any [sales] tax imposed . . . shall be personally liable for the tax imposed, collected or required to be collected.”[viii]
The Tax Law[ix] also provided, in relevant part:
“‘Persons required to collect tax’ or ‘person required to collect any tax imposed by this article’ shall include: every vendor of tangible personal property or services; every recipient of amusement charges; and every operator of a hotel. Said terms shall also include 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 [the sales tax]; and any member of a partnership or limited liability company.”
During the years at issue, the Tax Law contained no factors to qualify or limit the liability imposed upon members of limited liability companies. Instead, the Tax Law imposed per se liability upon such members, stating that any member of a limited liability company was a “person required to collect any tax imposed by [the sales tax law], ” and “shall be personally liable for the tax imposed, collected or required to be collected.”[x]
Accordingly, if Taxpayer was a member of Business LLC during the audit period, he would be personally liable for the sales tax required to be collected and remitted to the State from the LLC.
After explaining that Taxpayer bore the burden of proof to overcome the presumed correctness of the Division’s assessment, the Court found that Taxpayer sufficiently met his burden to show that he was not a member of Business LLC during the years at issue.[xi]
The Court reviewed the evidence presented by the parties.
As proof that Taxpayer was a member of Business LLC, the Division referred to the consent signed by Taxpayer as an “investor,” the sales tax examination questionnaire for Business LLC signed by another person but identifying Taxpayer as a “managing member,” and the application to register for a sales tax certificate of authority signed by another person but identifying Taxpayer as one of two responsible persons of Business LLC.
Challenging this proof, Taxpayer provided copies of Business LLC’s K-1s for the years in question which indicated parties other than Taxpayer were the owners of the business. Taxpayer also provided the affidavit of Business LLC’s CPA, who claimed that Taxpayer: was not a member of Business LLC, mistakenly signed the consent based upon the erroneous advice of another CPA,[xii] and, in any case, did not have authority to execute the consent.
Taxpayer also noted that he did not sign the other documents that the Division relied upon, and referred to the affidavits of Business LLC’s managers, who attested that Taxpayer was not a member of the LLC.
In weighing the foregoing evidence, the Court determined that Taxpayer was not a member of Business LLC for the years at issue. Accordingly, Taxpayer was not liable as a responsible person of Business LLC based upon the status of being a member.
However, the Court continued – and this was the crux of the matter – individual liability for an LLC is not limited to just members of the business. The Court stated that, aside from the strict liability imposed on a member of an LLC, whether an individual is personally liable for tax under the Tax Law[xiii] is determined upon the particular facts of each case. The pivotal question to be resolved was whether Taxpayer had, or could have had, sufficient authority and control over the affairs of the LLC to be considered a person under a duty to collect and remit the unpaid sales taxes in question.
The Division determined that Taxpayer was a responsible person based upon the evidence attached to the auditor’s affidavit. As noted, a presumption of correctness attaches to a properly issued statutory notice issued by the Division and the taxpayer bears the burden to prove that the assessment is incorrect. In this case, Taxpayer relied on the affidavits of the LLC’s two managers to establish that he was not a responsible person. Both managers attested that they were managers of Business LLC and Taxpayer did not manage the LLC during the time they held such positions.
The Court determined that, based upon the affidavits of the managers, Taxpayer met his burden of proof establishing that he was not a responsible person for the collection of sales tax.
However, as noted in their respective affidavits, the two managers’ assertions were limited to only a portion of the audit period. Outside of these time frames, Taxpayer failed to meet his burden of proof sufficiently to rebut the presumption that the Division’s assessment was correct.
Accordingly, Taxpayer was found liable as a responsible person of Business LLC for these other periods.[xiv]
Responsible Person Liability – Developments
New York’s Tax Law still imposes personal responsibility for payment of sales tax on each member of an LLC, regardless of whether the member is under a duty to act on behalf of the LLC.[xv]
A responsible person is jointly and severally liable for the tax owed, along with the business entity and any of the business’s other responsible persons. This means that the responsible person’s personal assets may be taken by the State to satisfy the sales tax liability of the business. An owner can be held personally responsible even though the business is an LLC.
Personal liability attaches whether or not the tax imposed was collected by the LLC. 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 LLC’s unpaid sales tax pass through to the responsible person.
Beginning in 2011, however, the State provided some administrative relief from per se personal liability for certain LLC members.[xvi]
Years later, a variation on this administratively provided relief was codified by the State as part of its 2018-2019 Fiscal Year Budget. Under that law, a member of an LLC continues to be treated as a “person required to collect” sales tax.[xvii] Thus, membership by itself remains a sufficient reason for imposing personal liability on a member for the LLC’s unpaid sales tax liability.
However, the law also provides that the State may grant a member relief from such per se 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) they were not under a duty to act for the LLC in complying with the sales tax.[xviii]
If the State approves a 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 up to the date the member makes pays the tax amount; the member will not be liable for any penalty owed by the LLC.
Shortly after the enactment of the foregoing statutory relief, the State issued administrative guidance to facilitate the its implementation.[xix]
Specifically, the State provided that an LLC member wishing to request such relief must do so by submitting Forms DTF-8, Application for Relief from Responsible Person Liability Under the Sales Tax Law, and CMS-1-MN, Request for Conciliation Conference. This application must be submitted before the liability at issue becomes fixed and final.
In addition, after acknowledging that an LLC member is expected to cooperate with the State by providing information known to the member regarding the identities of other potentially responsible persons, particularly those persons who were involved in the day-to-day affairs of the business, the guidance recognizes that certain LLC members, especially passive investors with only small ownership interests or distributive shares, may not know or have access to the information the State is seeking – in other words, such members will not be denied relief on this basis alone.
Finally, the guidance clarifies that certain LLC members will not qualify for relief, while others may not qualify:
- Not: an LLC member who holds a 50 percent or more ownership interest in the LLC, or is entitled to a distributive share of 50 percent or more of the profits and losses of the LLC; an LLC member who has acted or is under a duty to act on behalf of such LLC in complying with any requirement of the sales tax law.
- May Not: an LLC member who has been convicted of a tax crime; an LLC member who has a past-due tax liability, including the liability from which relief is sought.
Once the State approves the responsible person’s application and calculates their sales tax liability, the State will draft an agreement – to be executed by the responsible person – specifying the responsible person’s tax liability. The agreement will not be approved unless the responsible person pays the sales tax liability in full or enters into a satisfactory installment payment agreement.
Choice of Entity
The foregoing raises some interesting issues for an individual who is considering a passive investment in an LLC that expects to be subject to New York’s sales tax.
Notwithstanding the relief described above for members of LLCs, it may behoove such an investor to negotiate with the LLC and its other members for contribution or indemnity rights before the investor commits to the LLC.
The opinions expressed herein are solely those of the author(s) and do not necessarily represent the views of the Firm.
[ii] It is followed by its neighbor, New Jersey (another perennial bottom-feeder), at number 50. Massachusetts, Connecticut, and New Jersey complete the bottom five, in that order.
Speaking of good neighbors, earlier this month another suit was filed on behalf of New Jersey residents seeking to halt NYC’s latest congestion pricing proposal (the first of its kind in the country).
[iii] https://taxfoundation.org/data/all/state/taxes-affect-state-migration-trends/ . Joining New York in the group of top five losers: California, Illinois, Massachusetts, and New Jersey, in that order.
Please note the following: (a) Last Tuesday, Texas voters approved a ballot measure that denies the state the ability to impose a wealth tax; and (b) Jeff Bezos, of Amazon, announced he was moving his domicile to Florida from Washington just before the latter’s new tax on capital gains goes into effect.
Hope Albany is paying attention. Just saying.
The Office of the New York State Comptroller reported late last month that:
- NYC’s population fell 1.2% from 2017 to 2022, but the city’s gross domestic product (GDP) rose 8.2% during that period, accounting for more than 57% of the state’s GDP during each of those years.
- The number of city tax filers, including those with an adjusted gross income of greater than $1 million, and the city’s state personal income tax liability all declined as a share of the state total.
- In 2022, the number of city households in poverty increased over 2021, and is up 8.7% since 2017, reversing a downward trend seen before the pandemic. NYC households represented 43.4% of state households, but 54.7% of households in poverty in the state.
- The number of city residents receiving public assistance rose 16.6% from 2017 to 2022.
- The numbers of “cost-burdened” homeowners and renters in the city both rose from 2017 to 2022, up 11% and 4.1% respectively.
[v] ALJ Determination Carlo Seneca : DTA NO. 829298.
[vi] Taxpayer’s representative stated that he was familiar with this consent signed by Taxpayer and was present when Taxpayer signed the consent. He also stated that the consent was given based upon the erroneous advice of another representative (who subsequently passed away). He added that Taxpayer was not authorized to execute the consent on behalf of Business LLC.
[vii] On form DTF-17.
[viii] Former § 1133 (a).
[ix] Tax Law former Sec. 1131 (1).
[x] Tax Law former Sec. 1131 (1) and former Sec. 1133 (a).
[xi] Tax Law former Sec. 1133 (a) was amended, effective April 12, 2018, to provide that if a limited partner of a limited partnership or member of a limited liability company applies to the Division for relief and demonstrates to the satisfaction of the Commissioner that such limited partner’s or member’s ownership interest and the percentage of the distributive share of the profits and losses of such limited partnership or limited liability company are each less than fifty percent, and such limited partner or member was not under a duty to act for such limited partnership or limited liability company in complying with any requirement of article 28, that the limited partner’s or member’s liability will be limited to reflect such limited partner’s or member’s ownership interest of distributive share of the profits and losses of such limited partnership or limited liability company, whichever is higher. The relief provided for in the amendment was not in effect during the periods at issue, and as noted above, Tax Law former Sec. 1131 (1), as in effect for the periods at issue, imposed strict liability upon members of a partnership or limited liability company.
[xii] Query why the LLC’s CPA did nothing at the time to prevent this error.
[xiii] Former Sec. 1131 (1).
[xiv] Would King Solomon have approved? Kings 3:16-28.
[xv] Tax Law Sec. 1131(1).
[xvii] Note that a shareholder of a corporation is not, as such, a “person required to collect tax.”
[xviii] Tax Law Sec. 1133(a)(2).
[xix] TSB-M-20(2)S. In addition to what is described in the body of the post, the guidance explains how the sales tax liability of an eligible LLC member will be determined.