When one thinks of Texas and taxes, the idea that Texas does not have an income tax may come to mind. This is true. Texas does not currently have an income tax. This does not mean that Texas does not collect taxes.
Texas collects taxes–and a lot of taxes. This includes everything from property taxes to sales taxes to franchise taxes and other miscellaneous taxes–most of which greatly exceed the amounts imposed by other states that have an income tax.
Unlike the rules for income taxes, these “other taxes” are often more difficult to compute, and defend on audit, and, as with nearly all states, Texas’ system for collecting unpaid taxes is not nearly as manageable as the IRS’s collections.
This Texas tax system leads to common questions about how to avoid future tax disputes involving Texas taxes. This article addresses one such question; namely, whether a business owner is liable for one of these “other taxes” that its business may owe to the state. The recent Texas SOHA Decision 202208005H provides an opportunity to consider this question.
Facts & Procedural History
The taxpayer was the sole owner of a trucking company. The trucking company incurred International Fuel Taxes and Texas was its home state.
The Comptroller issued a delinquency notice to the company for Texas Franchise Tax in January 2017. The company closed in February 2017. The Texas Secretary of State forfeited the company’s charter in July 2017.
In September 2019, the Comptroller issued a Texas Notifications of Tax/Fee Due to assess personal liability based on the taxpayer’s status as an officer of the company.
The taxpayer filed a redetermination to contest the IFTA tax on the basis that he did not operate the trucks. The Texas State Board of Administrative Hearings considered the matter and issued its Proposal for Decision which is summarized as follows:
Staff’s evidence establishes that the audit assessment of COMPANY is final, full payment on the liability has not been made, COMPANY failed to file its report year 2016 franchise tax report, the Comptroller forfeited COMPANY’s corporate privileges, and those privileges were not revived prior to COMPANY going out of business. Therefore, each of COMPANY’s officers and directors is subject to personal liability for corporate debts created or incurred in the period in which the corporate privileges were not in place. Staff’s evidence also demonstrates that Petitioner was the president and sole officer of COMPANY during the relevant periods and that the assessment of Petitioner is within the period that COMPANY’s corporate privileges were forfeited.
This is a typical fact pattern that presents the circumstances in which the question posed above often arises.
Forfeiture of the Business Entity
The law for this issue starts with the Texas Franchise Tax rules. The Franchise Tax return starts the process.
Section 171.251 states:
The comptroller shall forfeit the corporate privileges of a corporation on which the franchise tax is imposed if the corporation:
(1) does not file, in accordance with this chapter and within 45 days after the date notice of forfeiture is mailed, a report required by this chapter;
(2) does not pay, within 45 days after the date notice of forfeiture is mailed, a tax imposed by this chapter or does not pay, within those 45 days, a penalty imposed by this chapter relating to that tax; or
(3) does not permit the comptroller to examine under Section 171.211 of this code the corporation’s records.
This statute works hand-in-hand with Section 11.201 of the Texas Business Organizations Code:
A terminated entity may not be reinstated under this section if the termination occurred as a result of:
(3)forfeiture under the Tax Code.
Read together, these statutes require the taxpayer to file and pay Texas Franchise tax and prevent the entity from being reinstated unless the taxes are filed and paid.
Consequences for the Forfeiture
Once the entity is forfeited, there are several consequences. Section 171.255 of the Tax Code sets out several of these consequences:
If the corporate privileges of a corporation are forfeited under this subchapter:
(1) the corporation shall be denied the right to sue or defend in a court of this state; and
(2) each director or officer of the corporation is liable for a debt of the corporation as provided by Section 171.255 of this code.
With respect to the liability of the director or officer, Section 171.255 says that “each director or officer of the corporation is liable for each debt of the corporation that is created or incurred in this state after the date on which the report, tax, or penalty is due and before the corporate privileges are revived.”
This same section sets out the defense the only defense:
A director or officer is not liable for a debt of the corporation if the director or officer shows that the debt was created or incurred:
(1) over the director’s objection; or
(2) without the director’s knowledge and that the exercise of reasonable diligence to become acquainted with the affairs of the corporation would not have revealed the intention to create the debt.
If one cannot qualify for this defense, then the next series of questions relating to who exactly is the director or officer. The law is not really clear on this point.
Who is the Director or Officer?
A legal entity generally has owners and those who manage the business. The same individuals or entities may serve in these roles or they may be different individuals or entities.
With corporations, the shareholders own the corporation. The corporation may have a president, vice president, secretary, treasurer, or others who manage the business and the corporation may have a board of directors who oversee the officers. With LLCs, the members own the business and the LLC may have managers who manage the business.
Which one of these parties are directors or officers? The tax rules do not provide a clear answer.
What Does the Evidence Say?
For personal liability, the state has the burden to prove its case. To make this showing the state is limited to documents that it can get showing who the directors and officers were and perhaps even circumstantial evidence or testimony.
Corporations usually identify the directors and officers in their By-Laws and LLCs in their Company Agreements. These documents do not have to identify these persons, however. The directors and officers also do not have to be identified in the Certificate of Formation.
The Texas Franchise Tax may list the officer and the Texas Periodic Report may do so as well. The entity’s Federal tax return, bank account signature card, and similar records might also list who the officer is. This raises the question as to whether one can carefully avoid listing themselves on these documents and thereby avoid personal liability for Texas taxes. The statutes seem to suggest this answer.
Even then, the law does not require directors and officers to be individuals. They can be other legal entities or even trusts. And these legal entities could have parent entities–even out-of-state or foreign parent entities or trusts. The statutes also suggest this as a possible answer as to who might be liable for Texas state taxes.
Of course, these factors were not present in the current case. The taxpayer was apparently the sole owner of the entity and he operated the entity himself. The state only imposed personal liability for taxes created or incurred in the period in which the corporate privileges were not in place. This too suggests that an answer might be to change the directors and officers prior to the forfeiture taking place.
A little advanced tax planning can go a long way in avoiding disputes. This is especially true for Texas state taxes that are incurred by businesses.
Texas business owners may be able to avoid or mitigate their personal liability by carefully considering these rules before a tax arises.