ASK THE CALIFORNIA EMPLOYMENT TAX AND PAYROLL TAX ATTORNEY SUCCESSOR LIABILITY AND HOW TO AVOID BEING A TARGET THE RUZBEHJON CASE PART 1
By Robert S. Schriebman
This is Part 1 of a 2-Part Series that will discuss procedures used by EDD collectors for unpaid corporate level or LLC level payroll taxes.
In May 2019, the California Office of Tax Appeals (OTA) issued a decision in the Ruzbehjon, Inc. matter. This case involved the non-payment, at the corporate level, of sales taxes owed by the corporation prior to its sale. Even though this is a matter involving the California Department of Tax and Fee Administration (CDTFA), the principles are very important and equally apply to the non-payment of EDD corporate level/LLC payroll taxes.
In this article, I will give you an overview of weapons used by tax collectors against transferees of business assets who fail to take into consideration the unpaid taxes owed by the seller corporate or LLC transferor. I will discuss the EDD version of successor liability and compare it to the doctrine of alter-ego. I will then discuss these principles in light of the Ruzbehjon case. I will conclude this discussion by giving you some pointers on how to avoid successor liability exposure.
EDD Collector Weapons: Alter-Ego and Successor Liability
Debts owed to the EDD come about in two basic ways. After an EDD auditor issues a Notice of Assessment, it is up to the taxpayer to timely file a petition with the CUIAB. If a timely petition is not filed, the assessment becomes final and subject to collection. Likewise, if a corporation or LLC files payroll tax returns but fails to pay, the matter is turned over to an EDD collector. If the business is sold before these taxes are paid, the EDD collector may have the right to pursue the buyer and make the buyer pay the seller’s unpaid EDD debts. The pursuit of 3rd party collection methods is strictly left up to EDD collectors. They have very few guidelines and can hit you without warning.
The usual targets for alter-ego collection are corporate or LLC owners, officers, shareholders and occasionally directors. Collection via the alter-ego approach is pursued by court action against the alter-ego of a corporation in those cases involving “closely held” corporations/LLCs and statutory “close” corporations having no shareholders’ agreement or acting contrary to such agreement. In such cases, where the shareholders are merely the alter-ego of the corporation, courts will treat the shareholders and the corporation as synonymous, rather than as separate entities, and hold the individual shareholders, officers and directors personally liable for the corporate obligations as a matter of equity.
Alter-ego pursuits are generally a last ditch effort by the EDD. They are also equally confined to large dollar cases. The burden of proof will rest with the EDD. The key element necessary to establish the alter-ego theory is the control of the corporation by an individual, group, or other corporation for the purpose of working fraud on corporate creditors.
When the EDD makes an investigation in an attempt to establish alter-ego, the following elements are deemed to be essential before the corporate or LLC entity can be disregarded:
- Inadequate financing of the corporation(thin capitalization);
- Lack of adequate corporate books and records;
- Commingling of funds and collection of corporate funds to be used for the purposes of those controlling the corporation or LLC;
- The fact that the corporation has been suspended for nonpayment of California franchise taxes; and
- Unpaid loans to stockholders, officers or directors.
Pursuant to CUIC §§ 1731-1733, any purchaser who does not avail himself/herself of the protection provided in the law becomes liable as of the date of the purchase of the business or as of the date his/her predecessor’s liability becomes final, whichever is later, for the amount due from his/her predecessor. However, no collection action can be taken against the successor until a Notice of Assessment is issued and becomes final. The EDD will usually direct its effort to collect against the predecessor. This policy will be adhered to only as long as it is apparent that collection in full can be made within a reasonable period of time, either directly from the predecessor or from his/her assets held by a third person. This policy will be disregarded if it appears that by delaying action against the successor collection of the amount due will be jeopardized. The successor is liable up to purchase price of the business. This can occur if the buyer or the seller neglected to obtain a release certificate from the EDD while the purchase transaction was in escrow. The measurement of recoverable liability, i.e., the “purchase price” can include the amount of accounts receivable.
A successor can be liable for the same penalties and interest charges as his/her predecessor except that he or she is not liable for penalties which have not been determined and are unpaid at the time of sale if the penalties are based upon negligence, intentional disregard of the law, fraud, or intent to evade any employment and withholding taxes. If these penalties are determined but unpaid at the time of the sale, the successor is also liable for these amounts in addition to all others.
The Ruzbehjon, Inc. Case
The Ruzbehjon, Inc matter was decided by the administrative Office of Tax Appeals on May 29, 2019. The matter involved a restaurant corporation that owed sales and used taxes in the amount of $39,000 for the years 2008 and 2009. The judge was a bit vague on exactly what was sold by the corporation to the purchaser as the judge stated, “…purchased the restaurant business from the corporation.” Later in the decision, it appeared that the buyer, Mr. Farahanipour (Mr. F.) actually purchased the stock of the company which carried with it all of the corporation’s underlying assets. Mr. F., in his zeal to own the restaurant, never took the time to obtain proper releases from the CDTFA. This paperwork usually consists of Tax Clearance Certificate or a receipt stating that the corporation’s taxes, interest and penalties had been paid in full. It also appears that this transaction occurred without the assistance of competent legal counsel. Mr. F. tried to argue that he should not be personally liable for unpaid corporate taxes, but his argument failed on deaf ears. Mr. F. was held personally liable to the extent that his purchase price covered unpaid sales tax liabilities of the seller.
In Part 2 we will learn the important statutes that were violated because Mr. F. did not take the time or have an interest in doing things properly.
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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