Business Owners Can be Personally Liable for Unknown State Taxes & Penalties

A few years ago, the 75 percent shareholder and president of a corporation visited the Chicago restaurant owned by the corporation to find it in disarray. Its manager was nowhere to be found and a search of the manager’s office found boxes of unopened correspondence and bills. The president turned the boxes over to his accounting firm. The restaurant’s lease was expiring, and given the problems it faced, the business was closed.

Among the liabilities that were overdue and waiting to be paid were various Illinois sales tax liabilities. The Illinois Department of Revenue (IDOR) held that the president was personally liable for penalties and interest for the late payment of sales tax; an amount of approximately $50,000. The matter ended in court.

The president argued that he was not the person responsible for filing Illinois taxes and did not willfully fail to file and pay the tax or willfully attempt in any manner to evade or defeat the tax so as to become personally liable for the tax under Illinois statutes. He noted that:

• He had originally owned 100 percent of the corporation, but had given a 25 percent interest (and a salary) to the manager for handling the restaurant and all its administrative matters (including taxes).
• He did not review financial matters for the restaurant. He only knew that it was not generating a profit and that vendors would only sell to it on a “cash on delivery” basis.
• He had never taken or received a paycheck and did not receive a distribution when the business was closed.
• He had made capital contributions to the restaurant for new equipment and décor.
• K-1s from the restaurant were the only financial information he received from the business.
• He placed a system into place whereby the restaurant’s manager and accountant ensured that taxes had been paid; this system had worked for 10 years.

The IDOR made the following points:

• The president had unquestioned control of the business.
• The president had signed a sales tax registration form for the business, which stated that he had personal responsibility for filing and paying Illinois sales tax. The president denies ever signing or even having seen the form before, but did not offer any evidence, such as a handwriting sample, to contest the authenticity of the document.
• The president had signature authority over the restaurant’s banking account.
• The president was aware of the restaurant’s financial difficulties.

The appellate court decided in favor of the IDOR. The court’s opinion noted:

• The burden is on the taxpayer to either establish he/she was not a responsible officer or that failure to pay the tax was not willful.
• A person need not have participated in the preparation, signing or filing of a tax return in order to be considered a “responsible person” under the statutes.
• If a person is in a position to easily discover a failure to pay taxes and did nothing, a finding of willfulness is justified.
• A person may not avoid personal liability for tax penalties for nonpayment of taxes by simply delegating the responsibility to other parties and failing to inspect corporate records or otherwise check on the status of returns and tax payments.

The court’s conclusion that the restaurant president was a “responsible party” should raise concerns with many corporate officers about how they can protect themselves from such situations. This concern should not be solely confined to current officers of a company. Often, in closely held or family businesses, an officer may exit the business, especially one that is “challenged,” such as the restaurant in this case. After the officer’s departure, bills or taxes (sales or employment taxes) may not be paid. If the business goes under, the IDOR may endeavor to obtain back taxes from the officers, including any officers that left the company previously, if the registration with the IDOR indicating the person was an officer, has never been amended.

An officer, such as a CEO or CFO may wish to retain the services of a tax professional to ensure that required returns are being properly filed with the IDOR and that payments are being correctly credited to the business account, not only for Illinois, but for any other states in which the business has a compliance obligation.