Update: The NYSDTF administrative policy of granting responsible person relief to certain minority members of LLCs has been codified into law by the New York State 2018-2019 budget signed 4/12/18.
Read this before investing in a New York Restaurant
All restaurants in New York will have the responsibility to collect and remit state sales tax. Regardless of the type of entity of the restaurant (Corporation or LLC), certain individuals who are active in the management of the restaurant may be deemed “Responsible Persons” and can be held personally liable for any outstanding sales tax liability of the restaurant.
If you ever have an opportunity to invest in a restaurant located in New York the first inquiry should be is the restaurant an LLC. The reason it is important to ascertain the type of entity of the restaurant is that all members of LLCs are “Responsible Persons” with regards to sales tax under the current New York Tax Law. This means a passive investor of an LLC would be held jointly and severally liable for any outstanding sales tax liability of the restaurant.
Unfortunate Scenario:
An individual decides to invest $25,000 in Restaurant LLC for a 10% interest in the LLC. The restaurant is losing money and after a couple of years cannot pay the rent and shuts down. The investor figures he has lost his entire $25,000 investment. Then 6 months later, the investor is notified that no sales tax returns have been filed and no sales tax deposits have been made by the restaurant for the last year of operations. There is a $180,000 sales tax liability that needs to be paid and the investor along with the other members of the LLC are all jointly and severally liable for the entire balance.
The Unfortunate Scenario above would have been prevented if the restaurant was set up as a corporation instead of an LLC. If the restaurant was a Corporation, then none of the passive investors would be considered “Responsible Persons” and therefore would not be personally liable for any outstanding sales tax liability of the restaurant.
New York Response to the Unfortunate Scenario Above:
The New York State Department of Taxation and Finance recognizes the unfortunate consequences to individuals who have no involvement or control of the business. The Department has developed a policy to provide relief to these individuals. To be eligible for relief an individual must:
(1) own less than 50% of LLC;
(2) have no duty to comply with the Tax Law on behalf of the LLC;
(3) be willing to cooperate with the Department by providing information to help identify other potentially responsible persons.
If you are granted relief, you may only be personally liable for your share (based on ownership % or profit and losses %) of the outstanding sales tax liability. In the scenario above, if the passive investor was granted relief, he would only be personally liable for about $18,000 ($180,000 X 10%) instead of being jointly and severally liable for the entire $180,000 balance.
This policy is a gift from the New York State Department of Taxation and Finance and is not recognized by law. In other words, this relief would not be granted by a court of law.
In conclusion, the type of entity of the restaurant is an issue to be considered by the investor. Investors investing in a New York restaurant are better protected with regards to outstanding sales tax liability by investing in a corporation versus an LLC.
If you would like further and more detailed information, please read TSB-M-11(17)S
Disclaimer: This article is offered for general information and educational purposes and not intended to be tax or legal advice.
Peter E. Alizio is a CPA, Tax Attorney, and owner of Alizio Law, PLLC. When he is not solving IRS and NYS tax problems he likes watching football and playing amateur chef. He also enjoys meeting new people, preferably over coffee, whiskey or cigars.