On March 9, 2011, the New York State Department of Taxation and Finance changed its policy concerning personal tax liability of minority owners of LLC or limited partnership for unpaid sales tax. Under the prior policy, minority owners could be held personally liable for unpaid sales tax even if they played no role in the business’s operation or had knowledge of the deficiency. This policy often led to harsh results; take, for instance, the case of Joseph P. Santos.
The facts in the case of “In the Matter of Joseph P. Santos” indicate that Mr. Santos was a minority member of an LLC who was a “Managing Member in charge of the daily operations of the company, [that] include[d] the operation of restaurant, which includes directing, manage the staff….” The LLC’s operating agreement provided no other function for Mr. Santos. In addition, the operating agreement stipulated that another member of LLC was designated the “Financial Managing Member” who was responsible for the preparation of “… all Federal, State and local income tax and information returns ….” Mr. Santos had no role in the preparation of the state sales tax returns. Starting in the second quarter of the 2005, the LLC gradually fell behind in its sales tax payments. During this period, Mr. Santos experienced serious health issues with cardiac arrest and undergoing radiation treatments for prostate cancer.
Although Mr. Santos was cleared of personal tax liability by the administrative law judge, the Tax Appeals Tribunal reversed the decision and held him personally responsible. The tribunal held that New York Tax Law “imposes strict liability upon members of a partnership or limited liability company” for unpaid sales tax. Essentially, the tribunal is stating that there are no defenses to members of limited partnership or LLC for unpaid sales tax under any circumstances.
The Department of Taxation and Finance was highly criticized for this extreme position and as a result modified its approach in March 2011. The Department of Taxation, itself, recognized that its position can result in “harsh consequences for certain partners and members who have no involvement in or control of the business’s affairs.” As a result of the policy change, a limited partner of a limited partnership or member of an LLC may have reduced exposure to personal liability for unpaid sales tax of the business organization that they belong to.
The revised policy applies to limited partners of limited partnership, who can show that they are under no duty to act in complying with the tax law. It also applies to members of an LLC whose distributive share of profits and losses from the LLC is less than 50 percent are under no duty to act on behalf of the LLC in complying with the tax law.
However, there are owners who do not qualify for the relief under the revised policy. They are: Any general partner of partnership, including general partners of limited partnership; any partners of limited liability partnership; or any LLC member who owns 50 percent or more interest in LLC or is entitled to distributive share to 50 percent or more of the profits and losses.
If a limited partner of limited partnership or a member of LLC otherwise qualifies for tax relief, the owner must enter into a written agreement with the Department of Taxation and Finance and cooperate with the department in providing information regarding the identities of those responsible for the day-to-day affairs of the business. This could imply testifying on behalf of the department at a judicial hearing.
Although eligible for relief, a limited partner of limited partnership or member of an LLC is still obligated to some amount of the unpaid sales tax. The application of the revised policy can be illustrated by the Department of Taxation and Finance’s Technical Memorandum of Sept. 19, 2011; for example:
An LLC [member] originally owed $10,000 in sales tax. Member X is a 4% passive member of the LLC and receives 4% of the profits and losses of the LLC. Member X has also been assessed the $10,000 on the grounds that Member X is a responsible person of the LLC. Member X has requested relief. If granted relief, Member X intends to pay the reduced amount [on agreed upon date]. The amount of accrued interest due on the original $10,000 computed through [ the payment date] is $1,600. If granted relief, Member X’s reduce liability would be computed as follows: $10,000 + $1,600 = $11,600 x 4% = $464.
The revised policy reduces, but does not eliminate, the unpaid state sales tax liability of certain partners in limited partnership and members of LLC. The rules for unpaid state sales tax liability are complicated. In some instances, an owner’s tax liability can be significantly reduced. For more on this topic, consult your tax adviser or attorney.
Larry Covell is a professor of business at SUNY Jefferson and an attorney. Contact him at email@example.com. His column appears every other month in NNY Business.