There isn’t enough attention paid to the risk that an individual can be held personally responsible for business sales and use taxes. The sales tax function is complicated enough without considering the potential for personal liability due to the failure to file or remit. Just ensuring proper sales tax compliance from the purchase order to the return could easily be more than one full-time job.
Common questions include: Are we registered? How do we format the data? Do we have the exemption certificate? Is this subject to tax? Through that fog, what often gets missed is that getting it wrong in just the right circumstances could be catastrophic for the individuals involved.
Another question that arises: Can a state really impose civil penalties or even initiate criminal proceedings against a manager, executive, or owner if a business fails to properly comply with the sales and use tax laws? The answer is yes—but you can prepare.
Spectrum of Risk
Owners, executives, and managers of middle- and small-market businesses are most at risk and need to be aware of how personal responsibility can attach to the initial sales and use tax registration or filing. Anyone in control over, or ultimately responsible for, the tax and accounting operations of a business should understand their role and the corresponding tax ramifications.
Importantly, one need not be an executive to be held personally liable. While CEOs, CFOs, and directors have been held personally liable—even though their day-to-day activities weren’t at all tax-related—personal liability can extend far down the employee hierarchy.
The sales tax is a trust fund tax; it’s collected as an agent on behalf of the state. A better way to think about trust fund taxes is to consider the business as stepping into the shoes of the state or locality when collecting the tax—the business is simply a steward of the funds until they can be properly remitted. The trouble starts when proper remittance doesn’t happen.
Activities that could lead to personal liability include:
- Being involved in deciding financial obligations that must be paid
- Having the power to hire and fire employees
- Having check signing authority
- Signing tax returns
- Having substantial authority over business decisions
Corporate officers, owners, and responsible parties of businesses with sales tax collection obligations should be aware of consequences for failing to timely remit the tax.
Personal Liability Scenarios
Personal liability arises in many scenarios, but here are two common examples. First, a business may be experiencing hardship and fail to remit the tax collected. A surprising number of businesses try to use sales tax collections as a source of revenue in hard times, opting to pay salaries or other expenses and not even realizing that this is a problem. These businesses usually intend to eventually remit the tax collected.
However, distressed businesses may feel hamstrung, that there is no other choice, and treat the tax as revenue. There may not be adequate funds to remit the collected tax when the business ceases operations, ultimately exposing responsible parties to potential taxing authority action.
Another example is due to nefarious or negligent treatment of the sales tax where businesses, or individuals within the business, collect the tax from customers without any intent to properly remit the tax to the state. While not likely a long-term criminal enterprise, such action may occur when businesses think they can escape notice from the taxing authority.
Impact of Personal Liability
Failure to remit sales and use taxes could result in the responsible person being individually liable for all collected but unremitted sales and use taxes plus penalties and interest. Personal liability for unremitted taxes could also extend to responsible parties with potential exposure to criminal penalties, which may include monetary fines and incarceration.
Most states have specific statutory or regulatory provisions for personal liability. While officers and owners can almost always be held personally liable for failure to remit sales and use taxes, employees with responsibility for financial decisions can also be liable under facts and circumstances tests.
These tests look to whether the individuals had access to bank accounts, made management decisions, signed or filed tax returns, signed checks or had any control over any financial matters or financial-related oversight, or authority to exert that oversight.
Ignorance of the sales tax compliance function is rarely a successful defense if the individual was an owner of the business, a corporate officer, or a party with any responsibility for financial decisions.
Preventing Catastrophic Failure
States don’t impose personal liability for business sales and use taxes in a vacuum. There are always compounding circumstances behind the variety of process failures that lead to an individual writing a check despite just being an employee or having limited liability protection.
The first step to preventing that result is to review your sales and use tax compliance process and implement controls that promote knowledge, transparency, and security. For example, many businesses create a sales and use tax policy that explains personal liability and requires employees to read and acknowledge that they understand the risk of failure.
Another option is to set up a segregated holding account for sales and use taxes to keep the funds held in trust for the state separate from operating revenues.
Most important can be implementing a variety of sales and use tax compliance steps that require multi-person integrity, so that no one person can make a bad decision with outsize consequences.
This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Brian Kirkell is a principal with RSM’s Washington National Tax practice where he leads the team focused on state and local tax compliance and policy.
David Brunori, Sr. is a director with RSM’s Washington National Tax practice where he focuses on state and local tax planning, policy and controversy.
Mo Bell-Jacobs is a manager with RSM’s Washington National Tax practice where he specializes in state and local tax compliance, controversy and policy analysis.
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