Dual Determination: The Liability Provisions for a Responsible Person under California and Federal Tax Law

What is a Dual Determination?

A “dual determination” is defined as a finding by a state taxing authority or a federal entity that a business entity’s liability may be assessed personally against an owner, officer, or other responsible employee of the business entity. A dual determination results in two mirroring assessments of the same liability, giving the government the right to satisfy the liability from any of the person, the business, or a combination thereof.

Federal Dual Responsibility Determinations

Under federal law, this takes the shape of a "Trust Fund Recovery Penalty" assessment under section 6672 of the Tax Code to impose personal liabilities against an owner, officer, or other responsible employee of a corporation, LLC, partnership, or other business entity. The key elements of the dual determination here, other than unpaid trust fund taxes, are that the person acted with “responsibility” and willfulness.

A responsible person is one who has "the authority required to exercise significant control over the corporation's financial affairs, regardless of whether [the individual] exercises such control in fact." United States v. Jones, 33 F.3d 1137, 1139 (9th Cir. 1994) (emphasis in original). A responsible person can be shown to be willful merely through "voluntary, conscious, and intentional act to prefer other creditors over the United States." Klotz v. United States, 602 F.2d 920, 923 (9th Cir. 1979).

Dual Liability Determinations Under California Tax Law

In California, the EDD (Employment Development Department) can similarly impose personal liability under Sections 1735 and 1735.1 of the California Unemployment Insurance Code (CUIC) for the full amount of its payroll tax liabilities where it can show a person was both responsible and willful with respect to the failure to pay the liabilities.

A person may be held personally liable for a business' unpaid sales tax if the elements of California Revenue & Taxation Code (RTC) § 6829 and Regulation § 1702.5 are met. Section 6829 requires that the person subject to dual responsibility for the taxes is both a “responsible person” and “willful” as to the nonpayment of taxes. The California Department of Tax & Fee Administration (CDTFA) will conduct an investigation to determine if an individual should be liable under these rules.

Different than IRS trust fund recovery penalty liability, the CDTFA regulation provides as a key element that the sales tax must have been collected, stating:

Personal liability shall only apply if the Board establishes that while the person was a responsible person, as defined in subdivision (b)(1), the corporation, partnership, limited partnership, limited liability partnership, or limited liability company:

1. sold tangible personal property in the conduct of its business and collected sales tax reimbursement on the selling price (whether separately itemized or included in the selling price) and failed to remit such tax when due...

(Different language is used regarding Use Tax.)

Regulation 1702 (without the .5) concerns "successor liability," which is defined by the statute includes not only a purchasor of the business itself (e.g. via a sale of the shares) but also a "stock of goods." This extends beyond the common-law definition of successor liability which is typically limited to where the court determines the acquiring party is effectively running the same business, not just acquiring assets.

Before the Dual Determination: The Investigation

When conducting its investigation to determine whether an employee or owner is a responsible person for purposes of applying dual-liability for the unpaid taxes, the government will first look to internal records (such as return filings) and public records (such as those on file with the Secretary of State) to see who are potentially responsible persons. Once those individuals are identified, they will reach out to them directly and ask for information orally, for documents such as bank statements and cancelled checks, and for completion of a Responsible Person Questionnaire. This is the Form 4180 in federal tax cases (click here for a PDF copy of the IRS's form previously used) . The CDTFA also has a Responsible Person Questionnaire (click here for a PDF copy of a blank CDTFA Responsible Person Questionnaire).

The federal Trust Fund Recovery Penalty is a serious and potentially-life changing penalty in and of itself because it makes one person responsible for the withholdings belonging to all the employees of a business. Moreover, the penalty is not dischargeable in bankruptcy (although our firm has experience compromising the penalty via IRS Offer in Compromise procedures). In addition, the IRS has referred a serious number of these cases for criminal prosecution. Consulting with an attorney is always advisable when confronted with a potential dual determination.

Updated on 11/09/2022 by Daniel W. Layton. This blog post is for discussion only and not intended to be legal advice for reliance in any particular case.