Corporations, Limited Liability Companies, General Partnerships, and Limited Partnerships are legal entities separate and distinct from their owners depending on what type of business structure the company has elected. Corporations, Limited Liability Companies, and Limited Partnerships all have varying forms of limited liability for shareholders and partners. There are times however, that there are exceptions to the limited liabilities of shareholders and partners.
Employer Liability for Failing to Withhold Taxes
If an employer fails to withhold taxes from his employees on the payroll, federal law mandates that the United States can assess a 100% penalty against any “responsible person” who was in charge of collecting tax withholdings from employees.
A “responsible person” is defined as anyone who possesses the actual authority or capability of paying the tax. A person does not have to be an officer of the company for that person to be the responsible person. Determining who is the responsible person focuses on who exercises control of the financial affairs of the company. Some different factors that are considered include:
- Status as an officer or member of the board of directors
- Ownership of a substantial amount of company stock
- Management of day to day operations
- Authority for hiring and firing employees
- Making decisions about disbursement of funds and payment of creditors
- Check signing authority.
For a responsible person be found in violation of failing to withhold payroll taxes there must be a finding of willfulness. Willfulness is defined as when a responsible person acts willfully when he or she makes the deliberate choice to pay other creditors rather than turning the taxes over to the government. Dillard v. Patterson, 326 F.2d 302, 304-05 (5th. Cir. 1963).
Minnesota law along with federal law also imposes liability for failing to withhold income taxes. Under Minnesota law personal liability applies to any person either individually or jointly with others who have “control of, supervision of, or responsibility for filing returns or reports, paying taxes, or collecting or withholding and remitting taxes.” Minn. Stat. § 270C.56, subd. 1. The case of Larson v. Comm’r of Revenue, 581 N.W.2d 25, 28-29 (Minn. 1998) provides the test when applying the statutory language. Per Larson, a person under Minnesota law is considered personally liable for failing to withhold taxes if that person represented himself as helping a company through financial difficulties and effectively controlled the company’s purse strings during a period in which the company failed to remit withholding taxes and sales taxes.
Unpaid Consideration to the Corporation
The second exception to limited liability is liability for unpaid consideration to the corporation. If the corporation is not paid fully before shares of stocks are issued; the person to whom the stock is issued is liable to the corporation for the difference between what was paid and the agreed consideration for the shares. Minn. Stat. § 302A.405, subd. 3. A director or shareholder that failed to vote against issuing the shares without full consideration may also be liable.
Corporate directors may be liable for illegal distributions. Distributions cannot be authorized by a board of directors unless the corporation can still pay its debts in the ordinary course of business. Minn. Stat. § 302A.551, subd. 1. If there is a distribution by the corporation and it is determined that the corporation cannot pay its debts, that distribution is considered an illegal distribution. Any directors who consented to that distribution are personally liable for the excess of the distribution over the amount that could have legally been authorized. Minn. Stat. § 302A.559, subd. 1.
The next exception to limited liability is liability of corporate officers for fraud. In State v. Alpine Air Prods, 490 N.W.2d 888, 897-98 (Minn. Ct. App. 1992), it was held that a corporate officer is personally liable if that officer committed fraudulent acts. However, a corporate officer is not personally liable for the torts of any employees unless that corporate officer actually participated in the tort. The Doctrine of Responsible Corporate Agents states that an officer is strictly liable for corporate action or inaction if that officer could have prevented the act or event that resulted in harm to the general public.
Lastly, the final exception to limited liability is the liability of shareholders and corporate officers for personal guarantees. If a shareholder or corporate officer signs a personal guarantee on a debt instrument such as a lease, bank loan, or promissory note on behalf of the corporation in their individual capacity, that shareholder or corporate officer is held personally liable for that debt. If a shareholder or corporate officer is going to sign a debt instrument, it is important that the corporate officer signs it in his or her corporate capacity, not personal capacity.