A Google search for “corporate accountability” nets 534,000 hits (with this writing, make that 534,001). Heavy interest in the topic is unsurprising, given the numerous corporate upheavals, scandals and the like over the past few years. In a business climate of budget cuts, employee layoffs and widespread reporting of corporate losses, corporate officers have become lightning rods for criticism, with many commentators demanding that executives be held accountable for their companies’ actions.
In the state tax context, however, there is certainly no lack of corporate officer accountability for their companies’ tax functions. In fact, most jurisdictions impose some level of direct personal liability on corporate officers and others responsible for certain of their companies’ unpaid state tax obligations.
In this article, we discuss the scope of that state authority, present our perspective on the interplay between state corporate officer liability rules and the federal bankruptcy code, and discuss mitigating the risk of personal liability.
The Corporate Veil: A Flimsy Shield Against Unpaid State Taxes
We’re just talking about sales tax . . . right?
States can and do impose personal liability on officers and directors for certain unpaid corporate tax liabilities, penalties and interest. The most common types of taxes for which personal liability arises are so-called “trust fund taxes,” such as state sales taxes, income tax withholding and similar obligations. Such taxes are collected from purchasers or withheld from employees on the state’s behalf, then held in trust by the company until later remitted to the state.
In certain instances, personal liability can also arise in the context of non-trust fund taxes. In New York, for example, a corporate officer can be held personally liable for unpaid use taxes (i.e., a company’s obligation to pay tax on its purchases when the vendor is not required to collect), despite the fact that use taxes are a direct obligation of the entity required to make payment, and are not collected and held in trust on behalf of the state. See Robert Landau v. N.Y. Tax App. Trib., 214 A.D.2d 857 (N.Y. App. Div. 1995). Moreover, prior to its repeal, Michigan statutorily imposed corporate officer liability for unpaid Single Business Tax (SBT) amounts, even though the SBT was not a “trust fund” tax — a singularly frightening thought, given the large use tax and SBT liabilities for some companies.
I don’t even do my own taxes, much less the company’s. So I have nothing to worry about . . . right?
States’ definitions of persons responsible for payment of their company’s taxes tend to be expansive, frequently extending liability beyond the tax department. Often, personal liability for a company’s unpaid state taxes arises when two conditions are met. First, the individual must be a person “responsible” for collecting and remitting the tax at issue. Second, the individual must act “willfully” in failing to pay over taxes.
In California, for example, a “responsible person” is defined broadly. Individuals potentially meeting the definition include, among others, officers, directors, managers and partners who are responsible for or who have control over the tax filings and payments, or who have a “duty to act” for the corporation. Willful behavior simply means behavior that is voluntary, conscious and intentional. So a responsible person must merely act with intent, and not necessarily with a bad purpose or evil motive, to be found personally liable for unpaid taxes.
Other states, like New York, do not explicitly define the term “responsible person.” Instead, New York simply indicates that “persons required to collect tax” are liable for the tax imposed, collected or required to be collected. However, that group of persons is defined in very broad terms — quite similar, in fact, to the universe of “responsible persons” under California’s definition. Unlike California, New York does not include a “willful” component for the imposition of personal liability. Rather, the question is simply whether an individual had a “duty to act.” Among others, New York considers individuals authorized to sign the company’s tax returns, responsible for maintenance of the company’s corporate books or responsible for management of the company to be under a “duty to act.”
Maybe Winston Churchill was correct when he suggested that “perhaps it is better to be irresponsible and right, than to be responsible and wrong.”
First-Day Orders: You Don’t Get a Second Chance to Make a First Impression
In the bankruptcy context, the automatic stay relieves the debtor company of immediate responsibility for payment of pre-petition debts, including most pre-petition state taxes. However, the automatic stay provides no such relief for responsible persons from their liability for the company’s unpaid state taxes. As a result, officers of troubled companies could potentially find themselves facing a tax burden that the company itself cannot pay as matter of federal bankruptcy law. Whether this result is supportable from a policy standpoint is beyond the scope of this article. However, the fact that this situation may exist highlights the importance of properly crafting first-day orders.
First-day orders are approved by the bankruptcy court and delineate the scope of certain post-petition actions that a debtor company can take, including the payment of pre-petition taxes. As such, it is in corporate officers’ and other responsible persons’, and by extension the company’s, best interests for the first-day order to be sufficiently broad in scope to authorize payment of pre-petition taxes for which personal liability could be imposed, including non-trust fund taxes such as New York’s use tax.
As an aside, first-day orders are often extended beyond those taxes that are subject to responsible person provisions. Most often the reasons are rooted in business, not tax, priorities. In the instance of taxes and fees imposed for the privilege of being organized under the laws of the state and/or doing business within the state, for example, allowing payment decreases the likelihood that government authorities could revoke the company’s ability to do business in the state, potentially leaving the company without access to the courts and a means to enforce its contracts.
A corporation’s payment of taxes subject to responsible person provisions avoids unnecessary and significant distractions that may “tax” (pun intended) the capacity of otherwise “over-taxed” executives and directors. The threat of personal liability can understandably cause corporate executives to take their eye off of the ball as they focus their attention away from the most critical issues — liquidity, negotiations with creditor groups, managing the reorganization, and the orderly administration of the bankruptcy case. To the extent the first-day orders can encompass payment authorization for a broad range of taxes, the likelihood of personal liability issues arising will diminish, along with the resultant headaches for the officers involved.
Alvarez & Marsal Taxand Says:
While states are not “out to get” corporate officers as a matter of course, they most certainly want to be paid the tax liabilities they believe are owed. To effect that goal, states will do everything in their power, whether payment comes from the business itself or from corporate officers or other responsible individuals.
Thus, corporate officers and other employees who could be deemed responsible persons should be acutely aware that their company’s failure to pay certain taxes could directly expose them to personal liability for unpaid taxes. Additionally, the incidence of personal liability does not always fall on the person most directly connected to a company’s tax function. Rather, a state may assert personal liability against multiple parties.
Particularly in the troubled company context, when federal bankruptcy rules can operate to prevent payment of certain taxes, it is crucially important for companies to be aware of how to reduce the risk of a jurisdiction imposing personal liability on their officers and other employees. In such instances, there can be tremendous benefit in consulting with your tax and bankruptcy advisors to ensure that the proper taxes are being collected and remitted or otherwise timely paid. Moreover, to the extent responsible person issues do arise, it is critical to seek professional advice as soon in the process as possible to mitigate the impact those issues have on the officers and other individuals within the organization.
The possibility may exist for a preliminary injunction against states seeking to collect pre-petition taxes from officers and employees, thereby providing another method of relief against what some consider to be an otherwise inequitable situation for the officers and employees. See, e.g., Gordon D. Henderson and Stuart J. Goldring, Tax Planning for Troubled Corporations Section 1102.4 (2009).
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The information contained herein is of a general nature and based on authorities that are subject to change. Readers are reminded that they should not consider this publication to be a recommendation to undertake any tax position, nor consider the information contained herein to be complete. Before any item or treatment is reported or excluded from reporting on tax returns, financial statements or any other document, for any reason, readers should thoroughly evaluate their specific facts and circumstances, and obtain the advice and assistance of qualified tax advisors. The information reported in this publication may not continue to apply to a reader's situation as a result of changing laws and associated authoritative literature, and readers are reminded to consult with their tax or other professional advisors before determining if any information contained herein remains applicable to their facts and circumstances.
About Alvarez & Marsal Taxand
Alvarez & Marsal Taxand, an affiliate of Alvarez & Marsal (A&M), a leading global professional services firm, is an independent tax group made up of experienced tax professionals dedicated to providing customized tax advice to clients and investors across a broad range of industries. Its professionals extend A&M's commitment to offering clients a choice in advisors who are free from audit-based conflicts of interest, and bring an unyielding commitment to delivering responsive client service. A&M Taxand has offices in major metropolitan markets throughout the U.S., and serves the U.K. from its base in London.
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