Originally published on Forbes.com Sept 30th, 2014
The limited liability company (LLC ) has been the entity of choice for many for quite a while. A domestic limited liability corporation is taxed as a partnership unless it elects to be taxed as a corporation. Generally, if you are not working in the business and trying to beat SE tax, an entity taxed as a partnership is a better deal than an S corporation. Among the reasons are that not just anybody can be an S Corporation shareholder, income allocation rules are rigid and S corporation shareholders do not get basis from their share of the corporation’s liabilities.
Of course, if it turned out that the limited liability of the LLC was not so limited, people might start taking another look at that entity choice A recent decision by the State of New York Division of Tax Appeals in the case of Eugene Boissiere and Jason Krystal might give investors pause as to the exposure they might take on by becoming LLC members – at least when they are investing in cash businesses in New York.
Tim Noonan of Hodgson Russ represented the taxpayers in this case. Tim told me that the underlying business of Ask 244, LLC was a night spot, on West 14th Street in Manhattan, called The Plumm. According to this story, The Plumm closed in April 2009. Ask 244 was assessed sales and use tax for the period June 1, 2004 through May 31, 2009 in the amount of $735,899.91. Then there was an unusual turn. Both Eugene Bossiere and Jason Krystal were assessed a total of $429,014.06 on November 15, 2010 for Ask 244’s sales and use tax for the period September 1, 2007 through May 31, 2009. The dates make me think that that was what was open on the statute when the state decided to start chasing them for the tax.
Mr. Boissier had a 14.9044% membership interest in the LLC and Mr. Krystal had 13.522%. After some negotiating the revenue department agreed to just chase them for “their share” – $20,202.81 from Mr. Boissier and $18,510.42 from Mr. Krystal. What, to me, is very unusual about this case is that it is not a “responsible person” case. “Everybody” knows that if you are in charge of paying bills and you pay money withheld for taxes to vendors and the like, you can be required to pay the withholding. Those cases tend to be rather fact intensive and get into the fine points of how much authority the “responsible person” actually had and how much they knew and when they knew it. None of those issues matter in this case.
It was conceded that neither Mr. Boissier nor Mr. Krystal had managerial responsibility, the ability to hire and fire employees, knowledge of or control over the LLC’s financial or the authority to sign returns. They did not participate in the audit of the LLC and do not know how the tax was computed. The assessment was based purely on their membership. By statute they could each have been assessed for the whole tax, as they were initially, but the Department of Taxation and Finance issued a policy statement in 2011 that recognized that the 100% liability can result in:
…unfortunate consequences for certain partner and members who have no involvement or control of the business’s affairs
Yah think?
It Is What It Is
Mr. Bossiere and Mr. Krystal tried to argue that the tax statute contradicted the statutes governing limited liability companies. The argument went nowhere, Administrative Law Judge Arthur Bray found the statute clear and unambiguous.
Having chosen to proceed as members of an LLC, petitioners must accept the consequences of their choice of business organization.
The judge there is, probably unwittingly, restating Reilly’s First Law of Tax Planning – “It is what it is. Deal with it.”
How Aware Are People Of This?
I have not found any coverage of this case, so I went looking for coverage of this trap that members of New York LLCs face. I found this article in The CPA Journal by Robert S. Barnett and this article in the New York Law Journal by Timothy Lewis. There are also some client alerts here and there like this one from Ellenoff Grossman & Schole.
Tim Noonan said that there was flurry of this type of activity by New York – i.e. chasing passive investors for sales tax – a couple of years ago, which seems to have subsided to some extent. Nonetheless, the law has not changed so that passive investors in businesses with significant sales tax exposure such as restaurants and bars need to be extremely cautious about getting involved as LLC members or limited partners, because, by statute their liability is not limited when it comes to sales tax. Tim did not think that investors had any idea that they were taking on this type of exposure when they signed up. Brian Gordon of Sanders Thaler Viola & Katz agrees that the sales tax exposure should incline investors in New York restaurants and bars to favor S Corporations.
If the only thing you have to consider is federal income tax, entity choice can still be a fairly complicated matter. This case shows that there are other issues that can sneak up on you that have noting to do with federal income tax. Robert Redford was in the news not long ago about a New York state income tax issue, that probably turned on someone not being aware of how having an S corporation in the chain of ownership affected allocations. Something tells me that when the decision was made to organize Ask 244 as an LLC rather than an S corporation, nobody was thinking about personal liability of members for sales tax.