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Ask The California Employment Tax And Payroll Tax Attorney – The EDD’s CUIC Section 1735 Assessment – Defenses That Work And The Defenses That Do Not

By Robert S. Schriebman 2020

Introduction

The EDD is allowed to ignore the protections afforded by corporations and limited liability companies (LLCs) and assess responsible individuals for every payroll tax dime owed by the entity. This is the essence of CUIC § 1735. There are many articles on this website that discuss 1735 assessments in general. This article will examine common defenses asserted by targeted individuals to deflect the potential 1735 assessment. I will also discuss the methodology used by the EDD in selecting the responsible person for assessment. In doing so, I will use as my example the recent Office of Tax Appeals (OTA) decision in B Kidd. In the Matter of the Appeal of B. Kidd, OTA Case No. 18043009, July 8, 2020.

You can learn about how one taxing agency, such as the EDD, operates by reading a decision involving another taxing agency. The principles of assessment and investigation are used by the EDD interchangeably with the OTA. In the case of B. Kidd, several unsuccessful defense tactics were asserted in an attempt to escape personal assessment for unpaid LLC sales tax. The very same defenses have been used in EDD assessments also without success. Here we will study these defenses and learn how the EDD gathers evidence against the targeted responsible person.

The EDD and the Case of B. Kidd

Kidd was a Texas oilman who invested in a successful West Hollywood restaurant. In 2008 and 2009 he had a partner, Mr. M., who managed the restaurant. Together, Kidd and Mr. M mismanaged the operation to the point where the restaurant owed unpaid sales taxes between September 2008 and June 2009 to the tune of over $81,000.

Kidd created an LLC known as Butter, and he filed all required documentation with the Secretary of State. He signed for a seller’s permit and also signed all relevant sales tax returns. When the LLC did not make sales tax payments timely, it was Kidd who contacted the then SBE to work out a payment arrangement. In 2008 and 2009, Mr. M wrote several checks out of the LLC payable to cash in the total amount of over $545,000. It appeared that Kidd and Mr. M may have been draining the LLC of its ability to meets its sales tax obligations.  During the time sales taxes were not paid, the LLC paid wages to its employees and payments to its suppliers, rent and utilities.

Defenses Presented by B. Kidd

The SBE conducted an audit and assessed Kidd personally for unpaid sales tax of over $81,000. Kidd attempted to deflect the proposed assessment with the following unsuccessful defenses:

  • Finger pointing contest: The most common defense in responsible person liability investigations is to blame others for your own actions. Sometimes, this argument says that Mr. A is more at fault than Mr. B the target. The OTA in the Kidd decision stated, “It is important to emphasize here that there can be, and oftentimes are, more than one responsible person held personally liable…it is not our role to determine whether a person is more or less responsible for Butter’s unpaid liabilities.” In other words, the defense of finger pointing rarely if ever works.
  • “I didn’t review the documents I filed.” This defense carries no weight and was ignored by the OTA.
  • “My signature was forged.” Here, Kidd accused Mr. M of forging his signature on documents filed with the SBE and the Secretary of State. Kidd also asserted that his signature was forged on tax returns. In response to this defense, the SBE hired its own handwriting expert who reviewed the filed documents and many checks drawn on Butter’s account. Kidd also hired his own handwriting expert who concluded that he could not state with certainty that the signatures were forged. The SBE’s expert was of the opinion that Kidd’s signatures were genuine. The OTA felt that the SBE expert’s testimony carried more weight.
  • Kidd argued that he did not manage the business because he was not a California resident. The evidence showed that Kidd was actively involved in another restaurant operation in Florida. Kidd argued that he was a Texas residence and was not physically present in California to operate the restaurant. The OTA ruled that modern technology allows anyone to operate any business remotely using email, a cell phone, and e-filing forms. You don’t have to be physically present in California.

EDD Investigating Techniques

Even though the Kidd case did not involve payroll tax deficiencies, the techniques used by the SBE are also used by the EDD. Here the SBE found that Kidd filed and signed documents with the Secretary of State, and also filed for sales tax permits. He negotiated a payment arrangement with the SBE as well as signed quarterly sales tax returns. The SBE also used EDD quarterly payroll tax returns that were signed by Kidd. Kidd’s signature was on the business license application. Most business checks were signed by Kidd. The large amount of cash drawn out of the company by Mr. M. may have been split between the two of them. The SBE also interviewed employees who testified as to Kidd’s physical presence at the company.

Conclusion

Whenever one forms a business, he/she leaves behind paper trails that point to management and control. The Kidd case also points out that most so-called defenses really hold no water. The best defenses have traditionally been the absence of one’s signature on tax returns, checks, and loan documents. Testimony from fellow workers, whether or not officers or supervisors, are also of key importance in establishing valid defenses. The key elements to liability have always been, and will continue to be, responsibility and willfulness.

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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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