ASK THE CALIFORNIA EMPLOYMENT TAX AND PAYROLL TAX ATTORNEY – BEING A SHAREHOLDER, DIRECTOR, OR OFFICER DOES NOT AUTOMATICALLY MAKE YOU RESPONSIBLE FOR UNPAID EDD PAYROLL OR SALES TAXES – PART 2: GUIDELINES YOU NEED TO KNOW
By Robert S. Schriebman 2020
This is Part 2 of a 2-Part series that will discuss the elements needed by the EDD and the CDTFA in order to make a personal level assessment for unpaid corporation or LLC taxes. Part 1 discussed the recent case of S. Arnold and the elements of responsibility and willfulness that caused Mr. Arnold to be personally assessed for unpaid corporate level sales taxes. In this Part 2, I will discuss the additional elements of knowledge, authority, and the ability to pay.
When a corporation or LLC owes delinquent EDD payroll or sales taxes, it is the job of the Collector to determine if there should be personal individual liability and if so, who should be assessed? The Collector will attempt to determine liability, but the determination will be more of a shotgun approach than an in-depth audit. The usual suspects are corporate officers, managers, or supervisors. Shareholders and directors also have exposure, but they can usually show that they have not been actively involved in the day-to-day fiscal affairs of the business.
There are several articles on this website that deal with individual liability for unpaid corporate and LLC payroll and sales taxes. The cases discussed in these articles generally deal with issues of responsibility and willfulness. Those have traditionally been the primary factors warranting personal level assessments. The Arnold case added additional elements to take into account.
On March 6, 2020 the Office of Tax Appeals (OTA) issued its decision In the Matter of the Appeal of S. Arnold, OTA Case No. 18043005. This case is noteworthy because the OTA discuss the additional elements of authority and knowledge. While the case involves unpaid sales taxes, it can be a guideline for EDD personal level assessments made pursuant to CUIC § 1735.
The Appeal of S. Arnold
Arnold was the president and sole shareholder of Legends, a furniture retailer located in San Diego, CA. Legends was incorporated in 1997 and ceased doing business in 2012. Legends owed unpaid sales taxes for periods 2007 – 2010. During this period, Ms. S was the office manager. She handled the bookkeeping and prepared all checks that required Arnold’s signature. The then SBE conducted an audit and determined that Arnold should be personally assessed for corporate level deficiencies. It was clear that Arnold was in control of the day-to-day fiscal affairs of the corporation.
The OTA determined that Arnold was ultimately responsible, but their analysis and discussion of various elements provides a guideline not only for sales tax assessments, but for EDD personal level 1735 assessments.
Guidelines for Establishing the Element of Knowledge
This element is fact-driven. In the case of S. Arnold, it was shown by the government that Mr. Arnold was a hands-on manager who reviewed bank statements, sales reports, and was aware of taxable sales on an ongoing basis. Small business owners tend to work 24/7 and micromanage the day-today business affairs. In Arnold’s case the government was able to show bank deposits that were twice the amount of what was reported on the sales tax returns. It was obvious that Mr. Arnold was knowledgeable about this huge discrepancy. He had no believable explanation of why he reported less than 50% of revenue as taxable sales.
Guidelines for Establishing the Element of Authority
A responsible person, the target of the assessment, must have the authority to pay taxes or cause them to be paid (i) on the date that the taxes came due, and (ii) when the responsible person had actual knowledge. It was proven that Arnold had the authority to pay the corporation’s taxes, or cause them to be paid, because he signed each return and personally filed tax returns during the periods in issue. He was also the only person authorized to sign checks for the company. Arnold was the corporation’s President, Chief Financial Officer, sole director and sole shareholder throughout the corporation’s entire existence. As such, Mr. Arnold had the authority to pay or cause the tax deficiencies to be paid when those taxes became due. This is a common occurrence for most small corporations and LLCs.
When it comes to EDD taxes, we see the same pattern in signing and filing quarterly and annual payroll tax returns. This is why the element of authority is not difficult for the EDD to prove. When there are two or more shareholders or officers, these types of situations become a finger pointing contest, and the results hardly ever work in the individual’s favor. The best defense is to obtain the testimony of coworkers who will testify as to whom actually ran the day-to-day fiscal affairs of the business.
Guidelines for Establishing the Element of the Ability to Pay
The element of the ability to pay is established by showing that sufficient funds came into the business during the period taxes were owed that could have fully paid the deficiencies. Instead of paying those tax deficiencies, the funds were used to pay the usual expenses of rent, utilities, inventory, and wages. It is easy for the EDD or the CDTFA to examine bank statements that show income and outgo. When the taxes are not paid, it shows a pattern of avoidance and it helps proves the government’s claim of willfulness.
There are sad scenarios where “corporate raiders” form a company and drain the proceeds of the company in order to line their own pockets leaving innocent people to take the blame for noncompliance. Even when it is clear to the government that this has happened, others become targets for personal level assessments and the bad guys walk away untouched.
I have always taken the position that the EDD and the CDTFA are looking through the telescope backwards. The important emphasis should not be on the company’s ability to have paid the taxes when the funds came in. When it comes to a personal level assessment, it is no longer a corporate or LLC issue. Personal liability should be assessed only if it can be shown that the individual has the personal ability to pay the assessment. Why assessed someone who cannot pay in the first place? All the government is doing when they make this kind of assessment is compounding the misery. The targeted individual does not have the means to reimburse the system. His/her only recourse is either a long-term installment payment arrangement that will never fully pay the assessment or an offer in compromise where the government accepts pennies on the dollar. It truly is a no-win situation.
There are essentially five elements that the EDD and the CDTFA must prove in order to go through the corporation or LLC to assess personal liability against so-called responsible persons. Many personal level assessments are justified; many are the results of taking a ‘shot-gun’ approach by the tax collector. If you become a target, you must be proactive. You have the burden of proving that you should not be assessed. Your best friends in these efforts are “paper and people.” You are essentially proving a negative. You must assemble the paperwork to show that were not responsible or your conduct was not willful. It is vital that you have on your side third-party witnesses. These are people who have hands-on knowledge of the day-to-day operations of the business, and who can testify on your behalf that others were in control at the time the taxes were not paid.
Robert Schriebman has a successful practice in the Rolling Hills Estates area of Los Angeles County serving clients throughout California and the United States. He has successfully dedicated more than 40 years to helping individual taxpayers, business owners, CPAs, Enrolled Agents, and tax attorneys navigate the complicated tax systems of the federal and state governments. Mr. Schriebman is in private practice. He is not affiliated in any way with the EDD and he is not employed by the EDD or any other agency of the State of California.
Robert Schriebman has written the only 2 books ever published dealing with how California Employment Development Department (EDD) operates. See “California Tax Collection Practice and Procedures” and “California Taxation Practice and Procedure,” both published by Commerce Clearing House.
Robert Schriebman has written over 20 books including the major manual used nationally by practitioners and the IRS, “IRS Tax Collection Procedures – A Manual for Practitioners” published by Commerce Clearing House.
Robert Schriebman has written over 20 books including the major manual used nationally by practitioners and the IRS, “IRS Tax Collection Procedures – A Manual for Practitioners” published by Commerce Clearing House in addition to the only 2 books ever published dealing with how California Employment Development Department (EDD) operates. See “California Tax Collection Practice and Procedures” and “California Taxation Practice and Procedure,” both published by Commerce Clearing House.
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