A trust fund tax is a tax that is collected and accounted for by a third party, usually a business, which is then responsible for remitting the collected amounts to the appropriate taxing authority. The amount collected from the person paying the tax is held for some period of time by the collecting party before it is ultimately remitted to the government that is owed the tax, hence the term “trust fund tax.” Such taxes are held in trust by the collecting party for the benefit of the government. For example, within the federal tax system, the Internal Revenue Code (IRC) explicitly provides that such taxes are held in trust for the federal government:
Whenever any person is required to collect or withhold any internal revenue tax from any other person and to pay over such tax to the United States, the amount of tax so collected or withheld shall be held to be a special fund in trust for the United States [IRC § 7501(a)].
Two categories of taxes generally fall under the classification of a trust fund tax: sales tax, which is collected from consumers, and employment—or payroll—tax, which is withheld from an employee’s gross pay.
Because the person or business collecting the tax for the government is generally allowed to hold the tax for some period of time before remitting the funds to the government, opportunities for impropriety arise. Similarly, the party required to collect the tax may choose to fail to do so, sometimes as an accommodation to customers or employees. For these reasons, trust fund taxes, both at the federal and state level, are often coupled with laws and rules that impose personal liability for the tax upon those who are deemed responsible for collecting and remitting the tax. Therefore, even those who operate businesses through limited liability vehicles, such as corporations and other limited liability entities (i.e., LLCs, LLPs), can find themselves personally liable for trust fund taxes, with the liability shield generally afforded to individuals who own and operate such entities inapplicable.
Because there is no federal sales tax, the most significant and common trust fund tax within the federal system relates to payroll taxes withheld from employee wages. At the federal level, an individual will be held personally liable for a trust fund tax if the individual was responsible for collecting the tax and “willfully” failed to collect, account for, or pay over the tax (IRC § 6672). Such an individual is generally referred to as a “responsible person” with respect to federal trust fund taxes. Note that, in order to establish personal liability, there is no requirement to establish that the responsible person acted with ill intent, in a nefarious manner, or with the intent to commit fraud. Simply failing to collect or remit the tax, so long as the failure was willful, triggers personal liability. Put another way, a company’s chief financial officer’s decision to pay the electric bill or a vendor and not pay over the withholding tax is ultimately a willful decision and could lead to personal liability. This is true even if the CFO did not benefit in any way from the failure to pay the withholding tax.
“Willfulness” in New York State
New York State tax authorities and courts have adopted the federal tests for “willfulness” in determining an individual’s liability for payroll withholding trust fund taxes. In accordance with the federal standard, a responsible person will be subject to personal liability for the failure to collect or remit payroll withholding tax to New York State if this failure is willful. As noted above, the bar to establish a willful failure is not high. Mere knowledge of the failure to pay and subsequent inaction may be sufficient for New York to establish that an individual willfully failed to pay the tax. The New York State Court of Appeals has adopted the “prevailing Federal opinion” and applied the test of “whether the act, default or conduct is consciously and voluntarily done with knowledge that, as a result, trust funds belonging to the Government will not be paid over but will be used for other purposes” [In the Matter of Levin v. Gallman, 42 N.Y.2d 32, 34 (N.Y. 1977)]. Citing federal appellate decisions in similar matters, the court further clarified that it is not necessary to show “intent to deprive the Government of its money,” only that “something more than accidental nonpayment is required.”
In New York State, where trust fund taxes encompass both payroll tax and sales tax, the bar for personal liability can sometimes be even lower. While New York uses a standard similar to the federal rule in determining responsible person status with respect to payroll tax liabilities, the test is different for the purpose of assessing sales tax liability and does not require that the individual acted willfully. Thus, in New York, a responsible person can be held liable for sales tax liabilities, whether the failure to pay the tax was willful or not.
Responsible Party Analysis under NYS Sales Tax Law
Section 1133a(1) of the New York State Tax Law provides that every person “required to collect” sales tax is a responsible person and can be held personally liable for such tax. More than one individual can be deemed a responsible person, and each individual is liable on a joint and several basis for the entire sum of unpaid tax, interest, and penalties. In turn, NY Tax § 1131 broadly defines those who are required to collect sales tax (and thus deemed responsible persons) to include:
any officer, director or employee of a corporation or of a dissolved corporation, any employee of a partnership, any employee or manager of a limited liability company, or any employee of an individual proprietorship who as such officer, director, employee or manager is under a duty to act for such corporation, partnership, limited liability company or individual proprietorship in complying with any requirement of this article, or has so acted; and any member of a partnership or limited liability company (NY Tax § 1131).
In New York, a responsible person can be held liable for sales tax liabilities, whether the failure to pay the tax was willful or not.
This definition of a responsible person can be broken down into two categories: 1) individuals who have a duty to act, and 2) members of a partnership or limited liability company (LLC), regardless of whether such member or partner had a duty to act. In effect, this definition imposes broad liability on officers, managers, and certain employees of a business required to collect sales tax and outright strict liability on partners of a partnership and members of an LLC.
Fortunately, there is some limited reprieve from the strict liability imposed on members of an LLC and limited partners of a limited partnership (LP), though this relief is not available to general partners of an LP nor to any partner of a limited liability partnership (LLP). If a member or a partner of an LLC or an LP demonstrates that their ownership interest and distributive share of profits and losses is less than fifty percent, and that they were not under a duty to act in connection with the sales tax at issue, then their personal liability for the unpaid trust fund tax may be limited to reflect their pro-rata ownership share or distributive interest in the entity. In addition, the partner or member will not be liable for otherwise applicable penalties.
Turning to the first, broader category of responsible persons—which can include owners, members, partners, as well as non-owner employees, officers, and managers—New York State law imposes personal liability on many unsuspecting individuals. New York State regulations determine whether an individual is a responsible person on a case-by-case basis, dependent upon the facts of a particular situation. Generally, individuals authorized to sign a corporation’s tax returns, responsible for maintaining the corporate books, or responsible for the corporation’s management, are under a duty to act and thus can be held personally responsible for failing to do so, even in the absence of willfulness.
Where Does Responsibility Lie?
New York State law casts a wide net when determining personal liability for trust fund taxes, extending responsibility well beyond formal titles and ownership stakes. Individuals with the practical authority or duty to pay trust fund taxes may find themselves facing personal liability for a failure to pay over the tax, even if they did not exercise that power or benefit financially. New York State and the courts will look at a person’s capacity to control financial affairs and respond to tax obligations over their mere formal role within an organization. Accordingly, anyone with actual or apparent authority over a business’s finances must remain vigilant, as even inadvertent inaction or unexercised powers can result in significant personal exposure under the state’s trust fund tax laws.
