Continuing Economic Distress: Withholding Taxes and the Risk of “Self-Help”
September 21, 2020
Stimulus Legislation Limbo
In has been 192 days since the President declared a national emergency concerning the COVID-19 outbreak.[i] Across the country, businesses and communities were immediately placed on lockdown[ii] in order to contain the virus. Unfortunately, this response plunged us into an economic crisis that continues to plague us.
Congress responded relatively quickly.[iii] Between March 3, 2020 and April 24, 2020, it enacted four major pieces of legislation aimed at stemming and, hopefully, reversing the damage inflicted on the economy.[iv]
These measures had a positive impact. There is no denying that the Paycheck Protection Program[v] has kept many businesses alive and has allowed others to retain their employees, while the Pandemic Unemployment Compensation Program[vi] kept many households afloat.[vii]
However, considering the size and severity of the challenges at which these measures were directed,[viii] and considering the temporary nature[ix] of the programs created by the legislation – the PPP stopped accepting applications after August 8, 2020, and the federal unemployment compensation payments stopped after July 31, 2020 – few can deny that more federal intervention is required; indeed, last month the Federal Reserve[x] warned that more economic stimulus measures are needed in light of what economists are describing as the longer-lasting impact of the pandemic.
That said, what has Congress – or, more accurately, the two major political parties – done during the 150-day period following the passage of the last relief measure? Mostly, nothing, though each party has proposed legislation that its leaders certainly knew would be unacceptable to the other – a $3.5 trillion relief plan introduced by the Democrats in May,[xi] and $1 trillion plan introduced by the Republicans in July.[xii] For example, after months of on-and-mostly-off discussions between the White house and the Democratic Party’s leadership, Sen. McConnell introduced a stimulus measure[xiii] on September 10 that failed to pass the Senate.[xiv] On September 15, the House’s bipartisan “Problem Solvers” caucus – don’t laugh – presented a $1.5 trillion middle-of-the-road stimulus package which received a cold reception from the leadership of both parties.[xv]
So, where are we now? The general elections are only 43 days from today. It appears that the chances of Congress’s passing any significant economic stimulus legislation before then, or during the immediately succeeding lame duck session, are remote. Thus, depending upon the outcome of the elections,[xvi] the earliest that new relief measures may be enacted is during January of 2021.[xvii]
Where does that leave the closely held business and its owners? The business may or may not have received a PPP loan;[xviii] it may be unsure whether the full amount of any such loan will be forgiven. It may have elected to defer (until the end of 2021 and 2022) the deposit and payment of its share[xix] of Social Security taxes on wages paid to employees through December 31, 2020.[xx] Like most other business owners, they are concerned about the future of their business, the state of the economy, the prospect of more federal relief, the likelihood of higher federal and state taxes, the possible resurgence of the coronavirus, etc.
Owners will do what they can to keep their businesses viable.[xxi] Although the great majority of owners will remain within the law, a not insignificant number may consider, and ultimately follow through with, a “strategy” that is often utilized by businesses in distress: failing to remit to the taxing authorities those taxes that the business has withheld or collected on their behalf – typically, the employee’s share of employment taxes on wages paid by the employer,[xxii] and state and local sales taxes.
Why would a business engage in such illegal behavior? The reasoning goes something like this: “Revenues were down. We just needed some time to recover – the tax money was going to help us sustain the business until it became profitable once again. At that point, we would have paid the taxes owing.”[xxiii] As you can imagine, it rarely works out that way, the business fails, and the owners are left holding the proverbial bag.
There are times, however, in which this decision is not adopted as a matter of “company policy” but, rather, is undertaken by only one well-positioned[xxiv] owner or officer of the business, unbeknownst to the others. As the co-owner of one New York business recently discovered, their inability to control the business may not be a defense against personal liability for such unremitted taxes.[xxv]
Whose Business Is It?
Taxpayer organized Corp, and had it certified as a minority business enterprise (“MBE”) in order to qualify for certain government-awarded projects.
At some point, Taxpayer asked Investor whether Corp could perform the “minority participation work” for Investor’s company (“IC”). Investor ultimately decided to invest in Corp, as a result of which Taxpayer became a 51% shareholder, with Investor owning the remaining 49% interest.
Investor became involved in the financial management of Corp. According to Taxpayer, Investor assumed responsibility for all “office” functions, including “payments and all the liabilities and distributions as far as checks and taxes,” while Taxpayer – who had no experience managing a business – remained responsible for projects in the field.[xxvi]
Corp’s checkbook was moved to Investor’s office. Taxpayer would travel to that office about once a week to sign checks prepared by IC’s controller at Investor’s behest, though Investor also maintained a facsimile stamp of Taxpayer’s signature, and would authorize its use without consulting Taxpayer. Taxpayer had no authority to issue checks without Investor’s permission.
Investor committed substantial sums of money to Corp, whereas Taxpayer invested little by comparison.
Taxpayer entered into an agreement with IC which recited that “[w]hereas [Corp] was indebted to [IC] . . . , and the parties desire to order their relationship in the event of certain contingencies,” the parties agreed that “upon the written demand of [Investor],” Taxpayer would resign his position as president of Corp, and would sell most of his shares of Corp common stock to Investor for a nominal amount.
According to Taxpayer, he entered this agreement because he needed the economic support of Investor and of IC.
During the tax periods at issue, employment tax returns were filed on behalf of Corp, some of which were signed by Taxpayer and others by Investor; of these, some were accompanied by checks and others without payment.
Taxpayer first became aware that Corp was delinquent with regard to New York taxes during one of the earlier periods at issue. At that point, Taxpayer negotiated[xxvii] the terms of an installment agreement to pay off a New York tax debt of $75,000. As part of that negotiation, Taxpayer completed and executed a “responsible person” questionnaire, on which he indicated that he “participate[d] in making significant business decisions,” and that he was “responsible for maintaining and managing the business.” With regard to the question whether he had authority to perform specified functions, he checked the “yes” box for the following functions:
- manage the business with knowledge and control over financial affairs;
- pay or direct payment of bills or other business liabilities;
- act, on behalf of the business, with the Tax Department;
- hire and fire employees; and
- negotiate loans, borrow money for the business, or guarantee business loans.
With regard to a question regarding Taxpayer’s “involvement in the financial affairs of the corporation,” Taxpayer responded “[a]ll financial affairs dealing with [Corp’s] day to day business.”[xxviii]
Taxpayer subsequently received a proposed assessment of trust fund recovery penalty[xxix] from the IRS, in excess of $10 million, which included the periods at issue with New York.
Taxpayer approached Investor and asked what he was going to do about the asserted tax liabilities. Investor responded that “this is my [i.e., Investor’s] responsibility. It is my money, I’ll take care of it.”[xxx]
Over time, Taxpayer continued to question Investor regarding Corp’s tax liabilities, and Investor would tell him, “don’t worry about it, I’m taking care of it, that’s my responsibility.” On such occasions, Investor would also remind Taxpayer that it was “his [Investor’s] company, his money.” According to Taxpayer, he had no ability to pay the tax debts without Investor’s approval, and the latter would not approve such repayments.[xxxi]
According to Taxpayer, Investor began to lose financial control of Corp as a result of Corp’s accumulating employment tax liabilities, plus a growing liability vis-à-vis Union. Investor attempted to negotiate a settlement with Union, as part of which counsel for Union asked that a “questionnaire” be completed on behalf of both Corp and IC. Investor forwarded the questionnaire to Taxpayer, who refused[xxxii] to complete it because, he said, he had no control of Corp’s finances and did not want to become personally liable under any settlement.
At that point, Investor exercised his right under the above-referenced agreement to purchase Corp stock from Taxpayer, and caused Taxpayer to resign his position as an officer of Corp.
New York’s Department of Taxation (the “Dept.”) issued notices of deficiency to Taxpayer, asserting withholding tax penalties for his “willful failure” to collect and pay over Corp’s withholding taxes when he was under a duty to do so (a “responsible person”).[xxxiii]
Taxpayer appealed the Dept.’s determination to the Division of Tax Appeals.
The Dept.’s Backup
The Dept. introduced bank signature cards for Corp’s account with Bank, including one that listed Investor, a replacement card that listed both Investor and Taxpayer which included a handwritten note that “[Taxpayer] may withdraw funds independently. Withdrawals by [Investor] must receive [Taxpayer’s] dual approval.”[xxxiv] A later card signed by Investor as “President,” removed Taxpayer’s authorization as a signer on the account.
In addition to the foregoing, Taxpayer represented Corp with regard to matters related to its MBE status, and even with regard to tax matters involving the Dept. For example, Taxpayer’s signature appeared on Corp’s application to register for a sales tax certificate of authority, which also identified Taxpayer as a “responsible person, with the title of president; it described Taxpayer’s primary duties as “[o]versees all business activities.”[xxxv]
According to the Dept.’s records, Taxpayer was identified as Corp’s contact person for corporation tax, sales tax, and withholding tax.[xxxvi]
The Dept.’s contact log also showed that Taxpayer spoke with the Dept.’s tax compliance unit a total of eight times regarding the taxes at issue, including conversations regarding the payment of the taxes.
Corp’s controller during the years at issue testified that all of the receipts for the two companies came to IC’s office, where they were transferred between Corp’s and IC’s bank accounts, as needed. According to the controller, it was Investor who determined which of Corp’s liabilities would be paid, including tax liabilities, and that if Taxpayer had directed her to pay those tax liabilities without the approval of Investor, she would not have done so. The controller testified that Taxpayer had no access to Corp’s checkbook.
An attorney who did legal work for IC and Corp testified that Investor was in complete financial control of Corp, kept Corp’s checkbook and the facsimile stamp of Taxpayer’s signature in his safe, and did not give Taxpayer access to either. The attorney also testified that Investor treated Taxpayer like an employee. Although Taxpayer enabled Investor to operate Corp as a minority enterprise, it was Investor’s business – “he put all the money into this business and it was his business. And he made that clear to everybody . . . including [Taxpayer]. It was not [Taxpayer’s] business to run.”
The ALJ’s Opinion
The Administrative Law Judge (“ALJ”) explained that the question of whether someone is a responsible person, under a duty to collect and pay over withholding taxes, ultimately turns on whether the individual “had or could have had sufficient authority and control over the affairs of the business to be considered a responsible officer or employee.”
The ALJ described the factors considered in determining one’s status as a responsible person for purposes of the withholding tax penalty, including the individual’s status as an officer, director, or owner of the business; authorization to write checks on its behalf; knowledge of and control over its financial affairs; authorization to hire and fire employees; whether the individual signed tax returns for the business; the individual’s economic interest in the business; and if the individual held himself out to third-parties as a responsible person.
The imposition of the penalty, however, required more than merely determining that an individual was a responsible person; it also had to be shown that such individual acted “willfully.” According to the ALJ, willfulness is shown through “conscious and voluntary acts done with the knowledge that the taxes would not be paid over, but rather used for other purposes.”
However, the ALJ also added that “a lack of knowledge that taxes were not being paid does not hinder a finding of willful failure to remit taxes, if the responsible person recklessly disregarded” their responsibility in seeing that taxes were paid.
After considering the various indicia of Taxpayer’s status as a responsible person for Corp, the ALJ concluded that Taxpayer qualified as a responsible person. In particular, the ALJ considered Taxpayer’s agreement to relinquish financial control of Corp to Investor while still exercising operational control. The ALJ also pointed to Taxpayer’s having continued to hold himself out as a responsible person for Corp even after becoming aware that withholding taxes were not being paid.
While acknowledging that a responsible person can make a reasonable delegation of responsibility, the ALJ found that Taxpayer’s delegation to Investor was unreasonable in the face of mounting evidence that Corp’s tax obligations were not being fulfilled. Because Taxpayer’s actions amounted to “more than accidental nonpayment,” the ALJ concluded that the willfulness requirement was met.
With that, the ALJ sustained the notice of deficiency,[xxxvii] and Taxpayer filed an appeal to the Tax Appeals Tribunal (“TAT”).[xxxviii]
Taxpayer argued that the ALJ incorrectly found that Taxpayer had sufficient control of Corp to be considered a responsible person. Taxpayer argued that he did not control Corp, and was thwarted in carrying out his duties. In particular, Taxpayer argued that access to a corporate checkbook was a significant factor in making a responsible person determination, and should be weighed in his favor. Taxpayer claimed that he had no actual authority, and could not pay the withholding taxes regardless of whether he wanted to. Thus, he argued, his actions could not be interpreted as willful.
The Dept. argued that the liability of a responsible person is personal in nature and cannot be avoided by pointing to another responsible person. The Dept. contended that finding an individual has control of a corporation does not depend on such individual’s actual assertion of such authority. According to the Dept., where “preclusion from carrying one’s corporate duties was foreseeable, and the product of” a taxpayer’s own actions, the taxpayer does not escape personal liability for the failure to collect and pay over taxes. The Dept., therefore, argued that Taxpayer’s disregard of his corporate responsibilities, by failing to ensure that tax payments were remitted to the state, met the requirement of willfulness.
According to the TAT, the question of whether someone qualifies as a person under a duty to collect and pay over withholding taxes is a factual one, and its resolution turns on a variety of factors, including those described in the ALJ’s opinion. Whether one held themselves out to third parties as a responsible person is also a factor to consider in making a responsible person determination.
The TAT considered whether Taxpayer presented facts showing that he lacked control and authority over the affairs of Corp. The TAT noted that Taxpayer was an officer of Corp and its majority shareholder, managed its field operations, had check signing authority, filed tax returns on behalf of the company, and had considerable economic interest in Corp. These facts, considered in conjunction with Taxpayer’s having held himself out to third parties, as well as to the Dept. itself in responding to its questionnaire, were uncontested and required the conclusion that Taxpayer qualified as a responsible person.
The TAT then observed that “willfulness” can be found where a responsible person recklessly disregards their corporate responsibilities, notwithstanding their lack of actual knowledge that taxes were not being paid. Corporate officers cannot absolve themselves, the TAT added, by disregarding their duty and leaving it to someone else to discharge. Similarly, declining to exercise one’s authority does not prevent one’s actions or inactions from being willful.
In the present case, the TAT continued, there was no question that Taxpayer left his duty to collect and pay over withholding tax to another person. According to the TAT, Taxpayer’s claims that he was “thwarted” in his attempts to comply with responsibilities for Corp’s tax obligations were difficult to reconcile with Taxpayer’s account of how different responsibilities for Corp were assigned since its formation. It seemed that the arrangement whereby Taxpayer claimed to have no control or authority to pay Corp’s tax obligations was one of his own making; it was a conscious and voluntary act that resulted in Corp’s failure to pay its tax. Even without knowledge that withholding tax would not be paid, this could be sufficient to sustain a finding of willfulness for purposes of the penalty. However, the TAT found that Taxpayer had actual knowledge that withholding tax was not being paid to the Dept. Thus, Taxpayer’s continued reliance on Investor to pay withholding tax constituted a reckless disregard of taxpayer’s duty to act.
Seems harsh, doesn’t it? It is clear that Taxpayer needed Investor’s financial support, and that Investor controlled Corp’s purse strings. However, the fact that Taxpayer “voluntarily” agreed to relinquish a measure of control over Corp was enough to doom him,[xxxix] notwithstanding that, as a practical matter, he could not compel payment of the delinquent withholding taxes.
The Dept.’s predisposition toward finding “willfulness” should dissuade any business owner from adopting the “company policy” described earlier.
That said, business owners also need to implement safeguards to ensure that no one of them, or any of the business’s key employees, is able to unilaterally divert any kind of withholding taxes toward the payment of business expenses. After all, the taxing authorities are not in the business of making loans to taxpayers.
[ii] Many are referring to this as the “Great Shutdown.” See, e.g., https://www.forbes.com/sites/iese/2020/05/14/the-great-shutdown-challenges-and-opportunities/#14206e8e6f12
[iii] And, I might add, effectively, under extreme circumstances. Yes, the legislation had its faults, there were parts that raised eyebrows, and pieces of it were difficult to implement, but when you consider the speed with which they acted to draft and pass these complex bills and get them to the President for enactment, they did a pretty good job. That’s why their subsequent performance and childish behavior are so disappointing.
[iv] The Coronavirus Preparedness and Response Supplemental Appropriations Act, P.L. 116-123; the Families First Coronavirus Response Act, P.L. 116-127; the Coronavirus Aid, Relief, and Economic Security Act, P.L. 116-136 (the CARES Act); and the Paycheck Protection Program and Health Care Enhancement Act, P.L. 116-139.
[v] “PPP.” It remains to be seen how the forgiveness stage of the forgivable loan program will be handled. We’ll know soon enough. And, yes, there were plenty of bad actors. Given the conditions and the circumstances in which they sought to take advantage of the rest of the public, the punishments meted out to them have been wholly unsatisfactory, at least insofar as having a cathartic effect upon the rest of us.
[vi] The $600/week payment. This program and the PPP were part of the CARES Act, passed in March.
[vii] An incidental benefit was realized by landlords and retailers – participating businesses were able to pay their rent, and households were able to shop for goods.
[viii] For example, over 20 million jobs lost in March and April 2020 alone; over 100,000 small businesses lost. https://www.washingtonpost.com/business/2020/05/12/small-business-used-define-americas-economy-pandemic-could-end-that-forever/. Many of these jobs have been recovered, but we remain millions behind from where we were before the pandemic.
[ix] Unlike my mother-in-law’s “sojourn” with us.
[xi] Which they have since slashed by about $1 trillion as a “show” of good faith.
[xii] I’m ignoring the questionable executive action taken by the President on August 8, 2020. https://www.nytimes.com/2020/08/08/us/politics/trump-stimulus-bill-coronavirus.html
[xiii] The “Delivering Immediate Relief to America’s Families, Schools and Small Businesses Act.”
[xiv] More accurately, the measure did not get beyond the Senate cloture rule which requires 60 votes to end debate on a proposal and then put it to a vote.
Of course, according to McConnell, the Democrats were to blame. And of course Schumer accused McConnell of using the vote as a campaign tactic.
[xv] Also last week, the Senate Republican leadership indicated it planned to send its members home to campaign – makes you question the wisdom of the 17th Amendment, doesn’t it – while Rep. Pelosi emphasized that she was ready to remain in Washington until a deal was negotiated.
As Stephen Sondheim wrote, “But where are the clowns? Send in the clowns. Don’t bother, they’re here.”
[xvi] If the Republicans somehow hold on to the White House or the Senate, deadlock may very well be the order of the day for many days to come.
[xvii] The 117th Congress starts on January 3, 2021, and the Presidential inauguration is on January 20, 2021.
[xviii] Approximately 5 million PPP loans were made, totaling well over $500 billion. https://www.sba.gov/article/2020/jul/13/sba-treasury-announce-release-paycheck-protection-program-loan-data
[xix] The employer’s share.
[xx] This deferral option was made available under the CARES Act.
The tax is equal to 6.2% of the first $137,700 of an employee’s wages for 2020. Mr. Biden has suggested eliminating the cap for wages in excess of $400,000.
Electing businesses will soon have to confront this deferred liability.
[xxi] With the Great Shutdown, commercial bankruptcies are up. https://www.taxlawforchb.com/2020/08/virus-to-economic-shutdown-to-bankruptcy-not-necessarily-but-be-prepared/
[xxii] The 6.2% Social Security tax and the 1.45% Medicare tax.
[xxiii] This has turned into a “refrain,” considering the number of such cases reviewed at both the federal and state levels.
[xxiv] “Well-meaning” is another story.
[xxv] In The Matter of the Petition of Christopher Black, Tax Appeals Tribunal, DTA No. 828015 (August 6, 2020).
[xxvi] Taxpayer managed projects, made sure jobs were billed correctly, and made sure jobs were completed on schedule.
[xxvii] Seemingly without the assistance of counsel.
[xxviii] Taxpayer later testified that he had answered the questions inaccurately because, he claimed, those questions as to his responsibilities with Corp were the same questions that MBE agencies used to audit his control over Corp’s operations, and he needed to be able to show that he maintained control over the corporation in order for Corp to retain its MBE status.
[xxix] For unpaid employment tax trust funds. IRC Sec. 6672.
[xxx] When later asked what he did to ensure that taxes were being paid, Taxpayer testified that “I couldn’t do anything about making sure that the taxes were being paid because it was his [Investor’s] money and his responsibility.”
[xxxi] When asked why he remained in his position with Corp as president even though he had no real control, Taxpayer replied: “Just trying to maintain my MBE certification” which, he believed, would provide opportunities for more contracts.
Ironically, the Port Authority later notified Taxpayer of its intent to decertify Corp as an MBE based on a report, the findings of which were described as follows:
“[Corp] is heavily dependent on another construction company, [IC], for financing, staffing, management and daily operations. [Investor], who also owns 44% of [Corp], owns [IC]. Although you referred to [Investor] as a ‘silent partner’, [Investor] exerts a substantial amount of control over the operations of [Corp].
“. . . [Corp] shares numerous management, office, and field employees, as well as equipment and warehouse space with [IC]. … You did not disclose this information in either the MBE/WBE Recertification Application or the [Background Qualification Questionnaires] submitted on behalf of [Corp] to work on WTC projects.”
A hearing officer upheld the proposed decertification of Corp as a MBE, citing, among other things, the existence of “several substantial non-documented interest free loans between [Corp] and parties related to [IC].”
[xxxii] On the advice of counsel. About time.
[xxxiii] Under NY Tax Law Sec. 685(g).
[xxxiv] The form also listed Investor as a responsible person of Corp, with his business title listed as vice president, and his primary duties described as “director of all business activities.
Taxpayer testified that the handwritten note was put on the replacement signature card in order to maintain Corp’s MBE certification at a time when he was trying to get Corp re-certified.
[xxxv] In connection with a sales tax audit of Corp, Taxpayer signed consent forms extending the statute of limitations for assessment. He also signed a statement of proposed audit change for sales and use tax. The record also contained a power of attorney, bearing Taxpayer’s signature, which appointed an attorney to represent Corp before the Dept. in withholding tax matters.
[xxxvi] A subsequent form also listed Investor.
[xxxvii] The IRS issued to Taxpayer a proposed assessment of trust fund recovery penalty, for unpaid employment tax trust funds, related to Corp under for some of the periods at issue with the Dept. Taxpayer argued that he should not be considered a ““responsible person” because he lacked financial control of Corp, which, instead, was controlled by Investor. Taxpayer submitted an affidavit in which Investor made the following statements:
“1. In addition to being a shareholder and director of [Corp], I held the corporate offices of secretary and treasurer, also. I have held these offices from the time I invested in [Corp] until the present. Neither [Taxpayer] (President/CEO for [Corp]) nor any other employee of [Corp] exercised control over the corporate disbursements (e.g., payments for vendors, creditors, union benefits and obligations, all payroll taxes, employer compensation and benefits, etc.).
- As Director/Secretary-Treasurer of [Corp], I had ultimate authority and absolute control over the financial disbursements of the company. I opened the bank account at [Bank] and added [Taxpayer] to the Master Signature Card and Agreement to Open Account(s) (the first signature card document for the [Bank] bank accounts (sic)….
- I controlled the payment of [Corp] bills and creditors at my office, which is separate and apart from [Corp’s] place of business. All correspondence, including bank statements came to my office. I handled all checking activity for [Corp] from my office. I kept the checks and check register at my office and only authorized personnel at my office had access to the checkbook. [Taxpayer] did not have access to the checkbook to make disbursements. I would direct my staff to write checks and [Taxpayer] would come to my office to sign the checks I authorized.
- … [Taxpayer], as President/CEO of [Corp], handled the operating activities of [Corp], but did not control any of the financial responsibilities and decisions of [Corp]. [Taxpayer] had signature authority on the bank account only to enable him to handle items related to running the operations of [Corp]; his authority did not include payment of [Corp] accrued liabilities, tax obligations, or anything beyond the company’s general operations.”
On the basis of the foregoing, the IRS Appeals Office determined that Taxpayer was not liable for trust fund recovery penalties.
Interestingly, both the ALJ and the TAT stated that the Dept. was not bound by determinations by the IRS. They rejected Taxpayer’s argument that such a determination was conclusive on the question of whether Taxpayer was a responsible person for purposes of the Tax Law.
Although the TAT agreed that NY Tax Law Sec. 685(g) and IRC Sec. 6672 were parallel statutes, and meanings given to terms used in the federal statute were relevant to construction of New York Tax Law (see NY Tax Law Sec. 607), such a principle did not require the Dept. to give deference to a factual determination of the IRS regarding the status of a responsible person. So much for conformity.
[xxxviii] Decisions rendered by the TAT are final and binding on the Department of Taxation and Finance, i.e., there is no appeal to the courts.
Taxpayers who are not satisfied with the decision of the TAT have the right to appeal the TAT’s decision by instituting a proceeding pursuant to Article 78 of the CPLR to the Appellate Division Third Department.
[xxxix] That, and his representation to the Dept. that he had authority, notwithstanding his inability to actually do anything.