When Business Becomes Personal
By: Caroline D. Ciraolo and Kamyar Mehdiyoun
© Maryland Bar Journal
Individuals are responsible for accurately reporting and paying their federal and state income tax when due. This is a universal truth. In certain situations, individuals are also personally liable for taxes owed by a business with which they are associated. This article reviews different types of federal and Maryland state taxes for which personal liability may be imposed.
Employment Taxes – Under the Internal Revenue Code (“IRC”), an employer is required to collect, account for and pay over taxes that have been withheld from an employee’s wages, including income and Social Security (FICA) taxes. If the employer fails to do so, under IRC § 6671 and § 6672, the Internal Revenue Service (“IRS”) may assess and collect these “trust funds” from individuals determined to be “responsible persons” who willfully failed to collect and/or deposit the tax.
The amount assessed against a responsible person is known as the “trust fund recovery penalty,” and is limited to the amount that should have been withheld from the employees’ wages. It does not include the employer’s portion of FICA or federal unemployment taxes. The penalty is a portion of, not in addition to, the employer’s liability.
A responsible person is someone who is responsible for withholding, truthfully accounting for, and/or depositing the tax with the IRS. To determine whether an individual is a responsible person, the IRS looks to the extent of control that person had over the employer’s finances. It considers a number of factors, including whether the individual was an owner or officer of the business, had the authority to sign checks, was involved in the daily operations of the business, and reviewed or signed employment tax returns. An IRS Revenue Officer will interview potential responsible persons and record those interviews on a Form 4180.
The Revenue Officer will also request certain business records, including bank statements, cancelled checks and signature cards, articles of incorporation and bylaws, employment agreements, and employment tax returns. It is common for the IRS to assess the penalty against more than one individual. If this occurs, the IRS may collect the entire liability from any of those persons, but may only collect it once.
Even a responsible person will not be held liable for unpaid trust funds unless the IRS determines that he or she acted willfully. Willfulness has been defined as intentionally using trust funds to pay other creditors in lieu of depositing those funds with the IRS, when the responsible person knows taxes are due or demonstrates reckless disregard for whether taxes have been paid. Mere negligence is not sufficient to establish willfulness. On the other hand, an employer’s poor financial condition is not a reasonable excuse.
Limitations – The IRS has three years from the April 15th following the year in which the liability arose to assess the trust fund recovery penalty. In other words, if an employer failed to pay during the second quarter of 2003, the IRS must assess the penalty against any responsible persons on or before April 15, 2007. However, if the employer files the return at issue after the April 15th of the following year, then the three-year period of limitations runs from the date the return is filed. If the return was never filed, the IRS takes the position that there is no statute of limitations.
Practice Tip: A representative should interview his or her client prior to meeting with the Revenue Officer, complete a Form 4180, and present it to the Revenue Officer. If the Revenue Officer requires a personal interview, during which he or she interviews your client and completes the Form 4180, you should review the Form 4180 with your client outside of the presence of the Revenue Officer, and make any necessary changes before your client signs.
Practice Tip: During the investigation, a representative should raise any other factors that may convince the Revenue Officer not to assess the penalty. Such factors include the age, state of health, and financial status of the person against whom the penalty is asserted. If the individual is financially unstable, then asserting that the tax is uncollectible may result in the Revenue Officer determining not to make the assessment.
Appealing an Assessment – If the IRS determines that an individual is responsible for the trust fund recovery penalty, it will issue a proposed notice of assessment, giving the individual the right to appeal by filing a written protest within 60 days of the date of the notice (90 days if outside the United States). An appeal should be filed to obtain an independent review of the Revenue Officer’s decision and to gain time for the employer to pay the liability before a penalty is assessed.
If a protest is filed, the case will be transferred to the Appeals Office for consideration. The individual has a right to a personal conference with the Appeals Officer, during which he or she may be represented and may present witnesses and evidence to dispute the assessment. If Appeals sustains the assessment, the individual has the right to pay a portion of the penalty, equal to the amount of tax due for one employee for one period, and then file a refund claim with a request for abatement for the remaining liability. If the IRS denies the claim, or fails to act within 6 months, the individual may initiate a refund action in the U.S. District Court.
Collection and Right of Contribution – The IRS may seek to collect the trust fund recovery penalty in the same manner as other taxes, including garnishing wages, levying accounts, seizing refunds, filing tax liens and suing to reduce those liens to judgment. The trust fund recovery penalty is not dischargeable in bankruptcy. If the employer or another responsible person pays the trust fund liability in full, the IRS will abate any remaining trust fund recovery penalties assessed against other responsible persons. If a responsible person pays the amount assessed, he or she has the right under IRC § 6672(d) to file suit for contribution against other “responsible persons” liable for that penalty.
Fuel Excise Tax – Where a business willfully fails to pay certain federal diesel, gasoline and fuel excise taxes, IRC § 4103 imposes personal liability on (i) officers, employees or agents of a business taxpayer who have the duty to assure the payment of such taxes, but who willfully fail to perform such duty; and (ii) anyone who willfully causes the business taxpayer to fail to pay these excise taxes. An individual’s personal liability for unpaid fuel excise taxes is determined using the same factors and analysis as the trust fund recovery penalty.
Withholding Tax – Personal liability for state income tax required to be withheld from a Maryland employee’s wages extends to any officer, agent or person who exercises direct control over the fiscal management of the employer, or is required to withhold and pay the income tax. Tax Gen. § 10-906(d).
Unlike the trust fund recovery penalty, which is limited to the amounts withheld from an employee’s wages, Maryland imposes personal liability for the entire amount due, including penalties and interest, currently accruing at the rate of 13%. Also unlike federal law, the Maryland statute imposing personal liability for withholding tax has no willfulness requirement. The intent of the employer or the individual, who may have acted reasonably in attempting to keep the business afloat during severe financial hardship, does not negate the personal liability of an individual who exercised direct control over the fiscal management of the employer. Nissenbaum v. Comptroller, M.T.C. No. 3374 (1991).
Sales and Use Tax – Personal liability for unpaid sales and use tax extends, in the case of corporations, to the president, vice president, and treasurer, as well as any officer who directly or indirectly owns more than 20% of the stock of the corporation. Tax-Gen. § 11-601(d). In determining whether an individual is liable, there is no “willfulness” requirement and no requirement that the individual exert any control over, or even be involved in, the financial management of the business. In other words, the statute imposes strict liability. Rucker v. Comptroller, 315 Md. 559 (1989); Shelley S. Wright v. Comptroller, M.T.C. 03-SU-00-0416 (May 25, 2005).
With limited liability companies, personal liability extends to all members unless there is an operating agreement. Where an operating agreement is in place, liability is limited to those individuals that manage the business and affairs of the company. The following acts do not constitute such management: (a) consulting with individuals who manage; (b) directing management in the same manner as a corporate director; or (c) voting on any matter required to be voted on by members.
For nonresident vendors, personal liability for sales and use tax extends to any salesperson, representative, peddler or canvasser whom the Comptroller elects to treat as anagent jointly responsible with the dealer, distributor, employer or supervisor under whom the individual operates or from whom the individual obtains tangible personal property or a taxable service for sale. Tax-Gen. § 11-101(o)(2). For example, an in-state dealer who solicited and wrote orders for an out-of-state manufacturer of log homes and then provided technical assistance to customers in constructing the homes, was a “vendor” jointly liable with the manufacturer for unpaid tax. Ridgewood Log Homes, Inc. v. Comptroller, 77 Md.App. 382 (1988).
Bulk Transfers – In the case of a “bulk transfer,” the transferee (or buyer) of an existing business may become personally liable for the prior owner’s sales and use tax liabilities if required notice of the transfer is not provided to the Comptroller. If in response to such notice, the Comptroller files a claim for tax due from the transferor, the transferee must withhold the amount claimed from the sale proceeds or risk personal liability for the amount due.
Admissions and Amusement Tax – The admissions and amusement tax is a local tax collected by the Comptroller on behalf of the counties. It is a tax on the admissions charge levied by various recreational and social venues, such as nightclubs, amusement parks, sports facilities, etc. If the business subject to the tax does not pay, the Comptroller may seek to collect the full amount due from any officer (in the case of a corporate taxpayer) or any individual who exercises direct control over the fiscal management of the business. Tax-Gen. § 4-301(b).
Tobacco Tax – The first Maryland wholesaler who possesses unstamped cigarettes is required to pay tobacco tax by purchasing tax stamps and affixing them to the cigarettes. If the wholesaler does not remit the tax, it becomes the responsibility of the retailer to pay the tax. The Comptroller may require a person who is subject to the tobacco tax to post some form of security to ensure payment. If a corporation is granted an exemption from this requirement, any officer of the corporation who exercises direct control over its fiscal management is personally liable for any tobacco tax, interest and penalties due. Tax-Gen. § 13-825(h)(6).
Motor Fuel Tax – The motor fuel tax is a tax on gasoline and other fuels imported, sold or used in Maryland. If a corporation is required to pay motor fuel tax, liability for unpaid tax, penalties and interest extends to any officer of the corporation who exercises direct control over its fiscal management. Tax-Gen. § 9-314(e). Excepted from this provision are officers of non-stock, not-for-profit corporations.
Withholding from non-resident contractors – Resident general contractors are required, when doing business with a nonresident general contractor under contracts entered into on or after July 1, 2003, that equal or exceed $50,000 or reasonably can be expected to equal or exceed $50,000, to withhold payment of 3% of the contract price until 30 days after the nonresident contractor has: (i) completed the contract; (ii) filed a written request for a tax clearance certificate with the Comptroller; and (iii) provided a receipted copy of the request to the person required to withhold the payment. Tax-Gen. § 13-803(b) (1). Within 30 days of receiving a written request, the Comptroller must furnish either a certificate of “no tax due” or a certificate that taxes are due, including the amount due including any penalties and interest.
If the nonresident general contractor does not request a tax clearance certificate within 30 days of completing the contract, or if the Comptroller issues a certificate showing a balance due, the resident general contractor must remit the 3% withheld to the Comptroller. If the resident general contractor fails to withhold or pay over to the Comptroller as required, it will be held personally liable for the tax, up to the amount that should have been withheld. Tax-Gen. § 13-803(d)(1).
Excepted from this requirement are property owners who contract for improvements of their owner-occupied residences and contracts for improvements to real property, or subcontracts thereunder, if the total value of the contract or subcontract is less than $500,000.
Limitations – The statute of limitations for assessing unpaid withholding tax is 3 years from the later of the date the return was due or filed. Tax Gen. § 13-1101. If no return was filed, or if the Comptroller can prove evasion, the tax can be assessed at any time.
For sales and use, admissions and amusement, and motor fuel tax, the period of limitations on assessment is 4 years from the date the tax is due. Tax Gen. § 13-1102. The Comptroller may assess at any time if the underpayment is due to fraud or gross negligence. An underpayment of 25% or more of sales and use tax due is prima facie evidence of gross negligence.
Appealing assessments – If the Comptroller determines an individual is liable for unpaid tax, it will issue a Notice of Assessment. The individual has 30 days from the date on the Notice to appeal by filing an application for revision of the assessment or, if the assessment is paid, a claim for refund. Tax-Gen.§ 13-508(a). If no action is taken within 30 days of the Notice, the assessment becomes final.
Practice tip: A business that receives a Notice of Assessment for these types of taxes should immediately determine which individuals received corresponding Notices of Assessment. As a general rule, appeals should be fled on behalf of each individual to prevent final assessments while the business is disputing the liability.
Once an appeal is filed, the Comptroller’s Office of Hearings and Appeals will schedule an informal hearing, during which the individual may present evidence and witnesses to dispute the assessment. Following the hearing, the Comptroller will issue a Notice of Final Determination. The individual has 30 days from the date of this Notice to seek review by the Maryland Tax Court. Tax-Gen. § 13-510(a).
Collection and Right to Contribution – Once an assessment becomes final, the Comptroller will request payment. If payment is not made, the Comptroller has a variety of tools at its disposal to collect the amount due. In addition to garnishing wages, seizing bank accounts and levying federal and state refunds, the Comptroller is authorized by statute to list delinquent taxpayers and the nature and amount of their tax liabilities on its website. This project, known as “Caught in the Web,” is an exception to the general rule of nondisclosure found in Tax Gen. § 13-202.
If the individual has a business or professional license issued by a state agency, the Comptroller will direct the agency to withhold the renewal of the license pending payment of the tax due. Licensed individuals include doctors, nurses, cosmetologists, insurance agents,electricians, boat dealers, real estate appraisers, and many others. Tax Gen. § 13-203(c)(5). The Comptroller may retain the services of a private collection agency and assess the taxpayer with the cost of collection. The Comptroller may also direct an employer to limit a delinquent taxpayer’s payroll exemptions to a number not exceeding the exemptions allowed on the employee’s prior year tax return. Tax Gen. § 10-910(b)(2).
To the extent an individual pays the assessment, he or she may seek contribution from other individuals liable for the amount due, based on the equitable principles recognized by the Court of Appeals in Lyon v. Campbell, 324 Md. 178,184 (1991).
Individuals should also be aware that in addition to personal civil liability, they could face serious federal and state criminal charges for tax-related offenses. These charges include willful failure to file returns, false statements, failure to collect or pay over tax, and evasion. In Maryland, an individual may also be charged with engaging in business without a valid license, failure to comply with a state wage garnishment, and even negligent failure to provide information under Tax Gen. § 13-1023. See Leet v. State, 203 Md. 285 (1953).
In light of the significant exposure, individuals should think carefully before accepting a position or title with a business that could subject them to personal liability for unpaid taxes. If you have a client that holds such a position, advise them to be vigilant with respect to the business federal and state tax filing, deposit and payment requirements. Finally, if someone is facing a proposed assessment of any of the taxes addressed in this article, they should obtain representation to protect their interests.