Personal liability for sales tax for members of a limited liability company has again been placed in issue in a case involving individual members who were precluded from exercising any involvement in the company’s business affairs that would have enabled them to comply with the company’s sales tax responsibilities. An Administrative Law Judge rejected the claim that this absolved them of personal liability, holding that their inability to pay sales tax stemmed from their voluntary decision to relinquish such involvement to a creditor of the LLC. Matters of James W. Henrie and Michael M. McBride, DTA Nos. 825871 and 825872 (N.Y.S. Div. of Tax App., July 14, 2016). 

Facts. Namwest, LLC, purchased a Holiday Inn hotel in Niagara Falls, New York. It then formed NS Partners, LLC, for the purpose of converting the hotel to a Crowne Plaza hotel. The two individual petitioners in question (Messrs. Henrie and McBride) eventually became members of NS Partners, and from the decision they appear to have exercised considerable control over its activities for several years, including signing various legal documents on its behalf. Although the ownership of NS Partners changed over time, during the periods in issue (three sales tax quarters in 2008) Messrs. Henrie and McBride each owned a one-third membership interest.

In March 2007, NS Partners refinanced a $30 million loan with its creditor, Grammercy Capital Corp. (“Grammercy”), on which the two individuals were made personally liable. Under the refinancing arrangement, Grammercy obtained a first-priority perfected security interest in the monies deposited into the LLC’s bank accounts from the hotel operations. 

In March 2008, NS Partners defaulted on its loan. Pursuant to the loan agreement, Grammercy stopped releasing funds from a lockbox to the NS Partners’ operating account and, together with its affiliate, Grammercy assumed complete control over the hotel’s operations and revenues. Although NS Partners made Grammercy aware that NS Partners was obligated to remit sales taxes to the State of New York, Grammercy did not release funds to NS Partners for that purpose. As a result, NS Partners continued to file quarterly sales tax returns but was unable to remit the sales taxes reported as due. The LLC’s sales taxes due for three sales tax quarters during 2008 were never paid, and the Department issued notices of determination to Messrs. Henrie and McBride for the unpaid sales tax, penalty, and interest of the LLC.

Following an audit of the personal income tax returns of Messrs. Henrie and McBride, which allowed them substantial refunds, the Department proceeded to apply those refunds against the sales tax liabilities asserted in the notices of determination. Messrs. Henrie and McBride then filed refund claims for the offset income tax refunds. Their refund claims were denied on the grounds that, as members of the LLC, they were per se liable for the LLC’s unpaid sales tax under Tax Law § 1131(1). This appeal followed.

Tax Law § 1131(1) defines a “person required to collect” sales tax, which results in strict personal liability, to include “any member of a partnership or limited liability company.” The Department has interpreted this provision as a per se member liability arising regardless of the member’s involvement in the LLC business or of its duty to act on the LLC’s behalf, a position that was upheld by the Tribunal in Matter of Santo, DTA No. 821797 (N.Y.S. Tax App. Trib., Dec. 23, 2009). 

Decision. At the administrative hearing, Messrs. Henrie and McBride claimed that they should not be held liable for the LLC’s sales tax obligations, despite being members of the LLC, because they were precluded from exercising any involvement in the hotel business after Grammercy seized control of the business in March 2008. The Division did not dispute that the individuals lacked control over the business, but maintained that NS Partners voluntarily relinquished control to Grammercy under its loan agreement. The ALJ held that, while a person who is precluded from acting on behalf of a business through no fault of his or her own will not be found personally liable for the sales tax liability of the business, in this case Messrs. Henrie and McBride were previously directly involved in the management and financial affairs of the LLC. The ALJ concluded that NS Partners voluntarily entering into an arrangement with its creditor that ultimately caused it to be unable to pay its sales tax liability was determinative of the outcome of the case. Under Tribunal precedent, including Matter of Button, DTA No. 817034 (N.Y.S. Tax App. Trib., Jan. 28, 2002), since the relinquishment of control over the management and financial affairs of the LLC “was a situation of NS Partners’ own making,” the ALJ held that the lack of control did not absolve NS Partners or its members from liability for unpaid sales tax. 

Messrs. Henrie and McBride also claimed relief under Technical Memorandum TSB-M-11(17)S (N.Y.S. Dep’t of Taxation & Fin., Sept. 19, 2011), under which in certain circumstances an LLC member’s per se sales tax liability is limited to the member’s percentage interest in the LLC. This would have limited their derivative sales tax liability to their respective one-third interests. The ALJ declined to invoke the TSB-M-11(17)S limitation, however, since by its express terms it did not apply to an LLC member having substantial involvement in the financial affairs and management of the business. According to the ALJ, since the individuals had substantial authority over the business until the event of default, the limitation was inapplicable. The ALJ distinguished the facts from those in Matter of Boissiere and Krystal, DTA Nos. 824467, et al. (N.Y.S. Tax App. Trib., July 28, 2015), where the Department did apply the TSB-M limitation to LLC members having no managerial or financial authority over the business. 

Additional Insights

It is interesting that even though the Tax Law provides strict liability for all members of an LLC, regardless of their duty to act, this decision principally focused on the LLC members’ actual inability to act on behalf of the LLC. Ultimately, the decision did uphold the imposition of full liability on the part of the LLC’s members, although seemingly not on the basis of per se member liability. It is also interesting that the ALJ declined to provide the TSB-M limitation of liability because the individuals were involved in the business, despite the fact that for the tax periods in issue they were no longer permitted to be involved in the business. As an aside, it should be noted that the Department applied the taxpayers’ personal income tax refunds against their sales tax liabilities, presumably based on its authority under Tax Law § 686(a) regarding the crediting of income tax overpayments against a taxpayer’s liability for other New York State taxes.