ASK THE CALIFORNIA EMPLOYMENT TAX AND PAYROLL TAX ATTORNEY – PRESENTING DEFENSES TO RESPONSIBLE PERSON EXPOSURE FOR UNPAID CORPORATE LEVEL TAXES
By Robert S. Schriebman
When a corporation or limited liability company fails to pay payroll or sales tax, the State of California can come after individuals charged with managing the day-to-day fiscal affairs or supervising tax compliance. You do not have to be a shareholder or even an officer to be held personally responsible. Any person required to collect, account for, or pay over these taxes faces personal exposure. If you find yourself on the hook for unpaid payroll taxes or sales taxes, you are welcome to use, in fact you have the duty to use, any defense possible. The EDD and the CDTFA have the burden of proof to show responsibility and willfulness. Common defenses include convincing the EDD or CDTFA that you are not personally responsible because you had no discretion or control, and therefore your actions were not willful. That in truth and in fact other persons within the organization managed, supervised and controlled payroll and sales tax functions.
When a potential client comes to me with this type of exposure, I ask some basic questions:
- What was your job title?
- What was your job description?
- Describe your daily routine
- Did you work under the direction or control of someone else?
- Were you supervised?
- Did you sign checks during the periods in issue?
- Who has the authority to sign checks?
- Did you prepare and sign quarterly payroll returns or sales tax returns?
- Did you contact the EDD or the CDTFA? (by phone or in writing)
- Did you negotiate an installment payment arrangement for the unpaid taxes?
The above is just a sample of the routine questions that must be asked and answered in order to determine available defenses.
After receiving answers to these questions, I then ask what may be the most important pragmatic questions of them all – Is there anyone in the company who can testify on your behalf? In my experience I have found that if you do not produce third-party witnesses, the answers to the above questions, while important, may not relieve you of liability.
On February 24, 2020 the Office of Tax Appeals (OTA) issued its decision in the Appeal of R. Yau. The Yau case caught my eye because of the defenses that Yau attempted to use, albeit without success. If he had been better prepared or had a bit more foresight, he may have dodged the bullet or at least reduced his exposure. In the Matter of the Appeal of R. Yau, OTA Case No. 18012001.
The Appeal of R. Yau
Yau owned and operated Habitant Building Supply & Lumber, Inc. (Habitant). Habitant filed unpaid sales tax returns for the period April 1, 2008, through December 31, 2009. After an audit of the company, the CDTFA charged Yau with personal liability for unpaid sales tax per R&TC § 6829. The audit disclosed that Yau signed and filed the unpaid tax returns. He was in charge of operations.
There are many articles on this website that go into great detail about the elements of personal liability. They will not be repeated here. What I found interesting about the Yau case was the discussion about personal liability for having not only control of the day-to-day fiscal affairs of the company, as well as tax compliance, but having exposure for supervision as well. In other words, a lower level manager or supervisor may have just as much exposure as the president or CEO. You do not have to own the company to be faced with personal liability for unpaid taxes.
Yau knew he had no place to run or hide being the owner of the company and responsible for tax compliance. He offered two defenses:
- An Affidavit from a third-party witness
- Accounts receivable – bad debt defense
An Affidavit from a Third-Party Witness
Yau offered into evidence at the hearing one affidavit from a previous employee which stated that Yau was not in charge of the corporation, but other corporate officers were. No person actually testified. The OTA brushed the affidavit aside and paid little attention to it. There is a lesson here – only the actual witness should testify in person. This will give the taxing agency representatives or a judge the opportunity to judge the credibility of the witness and to ask the witness questions.
Several years ago, I represented a young man charged by the IRS with millions of dollars of unpaid corporate payroll taxes. Fortunately, he had several witnesses who testified during the Appeals hearing. The witnesses were very credible. The results of the hearing were very favorable to my client. If I would have produced only sworn statements, it would have been a disaster!
Accounts Receivable – Bad Debt Defense
Yau argued that Habitant had large accounts receivable that were uncollectible and due to this, his sales tax exposure should be reduced accordingly. This was the first time I have come across this defense. I found it interesting how the OTA dealt with it.
Bad debt write-offs are complicated. There are plenty of federal tax cases that deal with the issue of when a debt is deemed uncollectible. The OTA cited an important State Regulation, 18 Code of California Regulations (CCR) §1642. This is a regulation explaining how a retailer is relieved from liability for sales tax if accounts receivable cannot be collected.
The OTA held that Yau could not merely make a verbal claim that the bad debt was not collectible. This would not suffice to reduce his personal exposure. If the receivables were uncollectible, Habitant should have filed one or more amended sales tax returns or filed a claim for refund. Since Habitant did neither, Yau could not persuade OTA judges to reduce his exposure.
Yau was found personally liable for every dime owed by Habitant. The lessons learned in the Yau case are important. First, only live witnesses should testify in any administrative proceeding – no written sworn statements unless they supplement oral testimony. Second, the accounts receivable defense is a good one, but it must be planned in advance by either filing amended returns or claims for refund.
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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