Commentary: Limited liability? Not so fast

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Most attorneys will recommend that when starting a business, a client should form some sort of entity to limit the personal liability that the business owner may face.

Usually, this involves a conversation on the limits of a corporation’s or LLC’s liability protection, including a respect for the entity’s separate legal existence to avoid the “piercing of the corporate veil.” Not often enough, however, does this discussion include a warning that an entity provides no protection against personal liability for employee withholding or sales taxes.

Liability for unpaid employee withholding and sales taxes will, by virtue of provisions in the Internal Revenue Code and/or the Wisconsin Statutes, pierce any liability shield that can be provided by an entity.

I will spare readers any statutory quotations, but the general rule on both the federal and state level is that a person who is responsible for (1) collecting employee withholding or sales taxes, (2) accounting for those taxes, and (3) paying those taxes over to the government can ultimately be saddled with personal liability for the debt if the business does not pay the taxes.

This personal liability for tax debts is not limited to the owners of the business. Any person who meets the statutory requirements can be personally liable. This includes a business’ owners, officers, directors, shareholders, partners and any employees charged with the responsibility of making sure the taxes are collected and paid.

Anyone who has the power to see that the taxes are collected and paid over to the government authorities will be considered a potentially responsible person for the purposes of determining personal liability for these taxes. There may be more than one responsible person in any given business, and each responsible person will be liable for the full amount of the tax debt.

While a right of contribution exists between multiple responsible persons, this issue will not be considered by the tax authorities in determining from whom they should collect the debt.

Federal and state differences

There are some conceptual variations between the federal and state statutes imposing personal liability. These differences include the fact that the liability imposed by the Internal Revenue Code is really a penalty equal to the amount of the unpaid tax and not technically a liability for the tax itself.

As a result, liability for federal penalties and interest assessed against a business do not flow through to the individual(s) determined to be personally liable. Once a federal personal liability assessment is made against an individual, however, interest begins to accrue on that balance. On the other hand, the Wisconsin Statutes imposing personal liability for withholding and sales taxes trigger the direct imposition of the business’ tax, penalty and interest on the individual.

All clients should be advised of the potential for this personal liability for withholding and sales taxes in spite of the existence of a liability limiting entity. A good time to give this advice is on the formation of the entity. You should reiterate this advice in difficult economic times, when the business may be tempted to raid these funds for operating cash.

Clients should also know that the tax authorities seek to cast the personal responsibility net as broadly as possible and will pursue the easiest (i.e. wealthiest) target. One can hardly blame the authorities for doing so, but this should serve as a point of caution if your client is the wealthier of two or more business owners.

There are certain procedural steps that must be taken and requirements that must be satisfied before a person is, in fact, held personally responsible for these debts.

Unfortunately, the mere assertion of personal liability can require a costly challenge to that liability. For example, a challenge will have to be made if the allegedly liable person’s name simply appears on a bank signature card. This is common in family owned businesses, where sons and daughters are regularly found on the bank signature card but have no real authority to act on behalf of the business or pay its debts.

Any business owner will likely tell you that the assertion of personal liability against the children for the sins of the father (or mother) can result in an unpleasant holiday dinner.

Robert Teuber is a tax attorney with Weiss Berzowski Brady LLP in Milwaukee. He works with individuals and businesses in resolving tax audits, appeals, litigation and collection actions brought by the IRS and Departments of Revenue. Rob can be reached at 414/270-2538 or [email protected].