New York art galleries generally are required to collect and pay over to New York State any New York sales tax that arises from the sale of a work of art. Galleries that do not properly collect and remit sales tax from purchasers are directly liable for the tax, in addition to any interest and penalties.

The New York art community is no stranger to the dangers of failing to comply with New York sales tax rules. After the 2002 indictment of Tyco International's former chief executive, L. Dennis Kozlowski, for evading New York sales tax on $14 million worth of artwork, many buyers and art galleries were investigated and held liable for unpaid sales taxes.

As dealers discovered in 2002, it was not just the gallery as a corporate entity that could face liability for unpaid sales tax; the owner of the gallery and the persons responsible for the payment of taxes on behalf of the gallery could be held personally liable. A recent decision of the New York Tax Appeals Tribunal makes clear that if the gallery is organized as a limited liability company ("LLC") or a partnership, these aren't the only individuals at risk. Under the December 2009 ruling In the Matter of Santo, any member of an LLC or partnership can be held liable for the entire amount of the entity's unpaid sales tax (including penalties and interest), regardless of the member's day-to-day involvement in the company's business and regardless of the size of the member's interest in the LLC or, in the case of partners, the partner's status as a general or a limited partner.


The Santo ruling is less a change in the law than a shift in the state's enforcement policy. The New York statute at issue could not be more clear. Any person "required to collect any [sales] tax" is personally liable for the business' unpaid sales tax. New York Tax Law Section 1131(1) defines a person "required to collect any tax" to include "any member of a partnership or limited liability company." The statutory language imposing strict liability on "any member of a partnership" has been part of Section 1131 since its enactment in 1965. In 1994, the New York State Legislature expanded the provision to include "any member of a limited liability company."

As discussed more fully below, the sales tax rule is inconsistent with the basic rules governing partnerships and LLCs. Indeed, when the rule was initially extended to LLCs, some observers though that it was so inconsistent with the purpose of an LLC as to have been a simple legislative mistake. Perhaps as a result, the New York State Department of Finance and Taxation evidently chose for a number of years not to enforce the sales tax provisions against limited partners of limited partnerships and members of LLCs. To the extent that the more lenient enforcement policy was a deliberate one, the Department has clearly changed its mind.

The Santo Decision

In 2004, Joseph P. Santo and two other individuals formed a New York LLC to operate a restaurant. Mr. Santo, who primarily oversaw the management of the restaurant staff, contributed nothing to the LLC in exchange for his interest in it (which ranged over time from one third of the LLC to less than one quarter), was not in charge of the company's financial operations and was not responsible for filing any LLC tax returns. The restaurant eventually failed and bankruptcy proceedings for the LLC were commenced in 2006. New York State subsequently assessed Mr. Santo for the LLC's unpaid sales taxes, totaling almost $200,000 (including interest and penalties).

In March of 2009 a New York Administrative Law Judge ("ALJ") held Mr. Santo not liable for the LLC's unpaid sales because he "lacked the power to exercise the tax collection responsibilities on behalf of the LLC." The ALJ stated that Mr. Santo was "not an investor, was not involved in the day-to-day operation of the restaurant and was not responsible for the financial management of the business."

The ALJ did not address the statutory provision that imposes strict liability on members of LLCs and applied instead a different provision that holds the officers and employees of a business (whether organized as a partnership, corporation or LLC) personally liable for the business' unpaid sales tax if the officer or employee is "under a duty to act" for the business in complying with the applicable provision of the tax law. After finding that Mr. Santo was not under such a duty to act for the LLC, the ALJ cancelled the Department's assessment against him for the restaurant's unpaid sales taxes.

Mr. Santo's success was short-lived. In December of 2009 the New York State Tax Appeals Tribunal reversed the ALJ decision, ruled that the ALJ applied the wrong standard to Mr. Santo, and held him strictly liable for all of the LLC's unpaid sales taxes by reason of his status as an LLC member:

Petitioner was a member of a limited liability company and, as with members of a partnership, such members are subject to per se liability for the taxes due from the limited liability company. Since Tax Law Section 1131(1) imposes strict liability upon members of a partnership or limited liability company, all that is required to be shown by the Division for liability to obtain is the person's status as a member.

The Santo case is the first reported decision of the Tribunal that reflects the Department's shift in enforcement policy.

 A striking anomaly.

Enforcing per se liability may result in the collection of more sales tax, but the rule is inconsistent with the general New York law governing limited partnerships and LLCs, the rules governing other "trust fund" taxes such as federal and state withholding taxes on wages, and rules governing the liability for sales taxes of officers or employees of corporations. The New York State Bar Association, as well as tax practitioners have called for a change in the law; as of the date of this article, the New York Legislature has failed to act.

Partnership and LLC Law. The sine qua none of limited partnership law is the limitation on personal liability of an investor who does not participate in the management of the partnership. Similarly, under the New York State Limited Liability Law a person cannot be held personally liable for an LLC's debts "solely by reason" of the person's status as an LLC member. The imposition of personal liability for unpaid sales taxes on limited partners and LLC members is an anomaly, wholly at odds with the usual treatment of LLCs, limited partnerships and the those who own them.

"Trust Fund" Tax Regimes: The strict liability rule is also at odds with the rules governing other "trust fund" taxes. "Trust fund" taxes are taxes primarily imposed on one party, but collected and paid over to the government by another party. For example, federal and state taxes on wages are collected by an employer by withholding money from its employee's wages and then paying it over to the government. Sales taxes are considered "trust fund" taxes because the tax is primarily imposed on the purchaser of goods, but is collected and held by the business "as trustee for and on account of the State." Businesses (including art galleries) that fail to collect and pay over sales tax are liable for the tax, as well as interest and penalties.

"Trust fund" tax regimes typically impose personal liability only on "responsible persons," that is persons involved with a company's business and responsible for collecting the tax and paying it over to the government. For example, federal law imposes personal liability for unpaid federal withholding taxes (plus interest and penalties) upon persons required to collect, truthfully account for, and pay over the tax, who willfully attempt in any manner to evade or defeat it or the payment of it to the federal government. With respect to LLCs and limited partnerships, the IRS has ruled that it will impose personal liability on their partners and members for unpaid federal withholding taxes on wages only when the person is generally liable under state law for the debts of the entity. With respect to employment tax withholding, New York closely follows the federal rules and generally imposes personal liability for the failure to collect employment taxes only on "responsible persons."

The New York and federal rules imposing personal liability on "responsible persons" for employment withholding taxes make equitable and intuitive sense. After all, persons involved in the day-today business will have the relevant knowledge to ensure compliance and generally will be in a position to control the collection and payment of the tax. As intuitive and equitable as it may be, however, it is not the law when it comes to New York State sales tax.

Arcane laws can have surprising consequences.

Any number of dealers and galleries may be organized as limited partnerships or LLCs. These forms of organization have benefits that may suit the particular business (or portion of a business) of the gallery. However, galleries that have passive or minority investors or partners may want to revisit their corporate structure in order to protect those individuals. Investors in galleries or other art-related LLC'smay want to consider restructuring how they support the gallery – perhaps, for example, shifting from being a limited partner or LLC member to being a creditor. Alternatively, passive or minority investors and partners may want to consider requiring the gallery to certify periodically that all sales taxes have been duly paid. Absent legislation from Albany, these sorts of measures may be the only way to limit what could otherwise be substantial liability.