Personal Liability for Debts

The most common way for an officer or governing person to become personally liable for the debts of an entity is by voluntary agreement. Contracts such as real property leases, bank loans, lines of credit, equipment lease or purchase agreements, and sometimes even supplier contracts, can require one or more personal guarantees in addition to the entity’s obligation to pay the amount due. If an officer or governing person of an entity signs a personal guarantee for one of the entity’s debts, they are fully liable for such debt, even if they do not have control over the entity’s fulfillment of the debt. This agreed liability will extend to cover all of the individual’s non-exempt personal assets, and lasts until the other party agrees to release them. A personal guaranty is not extinguished by a loss of employment, and can continue even if the officer or governing person is no longer associated with the entity.

Personal Liability for Taxes Collected

Under the Texas Tax Code (the “TTC”), certain types of business are responsible for collecting taxes from their customers, and then remitting those taxes to the Texas Comptroller. The classic example of this type of tax is sales tax, but it also includes hotel occupancy taxes, mixed beverage taxes, and other charges that are passed along to the customer. The taxes that are collected in this manner are not considered to belong to the business; rather, the business is holding these tax funds in trust for the state.

Section 111.016(b) of the TTC specifies that “an individual who controls or supervises the collection of tax or money from another person, or an individual who controls or supervises the accounting for and paying over of the tax or money, and who willfully fails to pay or cause to be paid the tax or money is liable as a responsible individual for an amount equal to the tax or money not paid or caused to be paid.” Note that the provision refers to “an individual” and not “a business”. The practical effect of Section 111.016 of the TTC is that the individuals within an entity that hold supervisory authority over the collection of taxes for the state are personally liable for making sure that the collected taxes are, in fact, paid to the state. This supervisory authority is typically held by the officers and/or governing persons of an entity. Lower-level, non-supervisory employees of an entity (for example, employees in an internal finance or accounting department) could also be liable under this section of the TTC.

Personal liability under Section 111.016 of the TTC has two components:

– The individual must either (i) control or supervise the collection of the tax from the entity’s customers, and/or (ii) control or supervise the payment of the tax to the state; and

– The individual must have willfully failed to pay the tax to the state.

If an officer’s or governing person’s role does not include anything to do with taxes, then there is little risk of personal liability under the TTC. However, the more global responsibility that an officer or governing person has over an entity that is collecting any state taxes – such as having the ability to vote in favor or against operational policies, actions, or procedures – the more the individual will be seen by the TTC as meeting the first component of personal liability.

As detailed above, tax funds do not belong to the entity that collected them. Thus, any spending of tax funds – whether to pay the general debts of the business, to pay wages, or even to pay other taxes of the entity – will generally satisfy the second component of personal liability. In other words, if an entity has the choice between using its limited cash on hand to remit sales taxes to the Comptroller, or to pay any other expense of the entity, then the officers and governing persons of the entity should remit the sales tax. If the entity’s officers or governing persons choose to prioritize some other expense over remitting taxes, even an expense as crucial as payroll or rent, then the officers and governing persons will likely be seen as having “willfully” failed to pay the tax to the state, because they have diverted the funds, they are holding in trust for the state to pay the entity’s other liabilities.

Note that the concept of willfulness does not include honest mistakes or miscalculations. If the incorrect amount of taxes is paid by the entity due to an error in determining the amount of taxes due, then even though there are additional taxes (and potentially penalties) owed by the entity, the officers and governing persons responsible for the entity’s payment of taxes will not have personal liability.

Personal Liability for Payroll Taxes

Similar to the Texas state taxes discussed above, payroll taxes that are withheld by an entity out of the wages of its employees do not belong to the entity, and are held in trust for the Internal Revenue Service (“IRS”). Section 6672(a) of the Internal Revenue Code (the “Code”) provides that “any person required to collect, truthfully account for, and pay over any tax imposed by this title who willfully fails to collect such tax, or truthfully account for and pay over such tax, or willfully attempts in any manner to evade or defeat any such tax” is personally liable to the IRS for the amount of uncollected, or unpaid, taxes.

The language in Section 6672(a) of the Code is quite similar to that of Section 111.016 of the TTC: liability is imposed on individuals that are responsible for either collecting or paying the tax, and willfully fail to do so. Also, like the TTC, the Code considers the use of payroll tax funds to pay unrelated debts of the entity to be a “willful” failure to pay such tax funds.

When it comes to determining which individuals are required to collect or pay payroll taxes, the IRS looks to anyone whose responsibilities cover the collecting, accounting, or paying of payroll taxes. An individual’s job title is not dispositive; rather, the IRS looks to the actual substance of an officer’s or governing person’s role in the entity, including whether they have the status, duty, and authority to control the entity’s finances. This could include any employee or officer with signing authority over the entity’s bank account, and anyone else with control over the payroll process, including mid-level managers and bookkeepers.

Personal Liability for Wages

An officer or director may have personal liability for the payment of wages, in certain circumstances. The Federal Fair Labor Standards Act (“FLSA”) requires that each employer pay payment of minimum wages and overtime. The term “employer,” under the FLSA, includes both the entity assigning duties and “any person acting directly or indirectly in the interest of an employer in relation to an employee” (see Section 203(d) of the FLSA). In determining whether an officer or governing person fills these roles, and is therefore personally liable for the payment of minimum wages or overtime, a court will examine whether such officer or governing person:

– Had the authority to hire or fire employees,

– Set the work schedule for workers under them,

– Had the authority to set any conditions regarding the length or number of permitted breaks,

– Has any control over when, or how much, employees are paid, and/or

– Is responsible for maintaining employee records.

In order an officer or governing person to be personally liable for unpaid wages, therefor: (i) the officer or governing person must have sufficient authority and control over the entity’s employees, and (ii) the entity must have failed to pay an employee at least minimum wage, or failed to pay properly earned overtime. Thus, an employee claim regarding unpaid bonuses is not likely to result in personal liability to the entity’s directors or governing persons.

However, the Texas Labor Code (the “Labor Code”) differs from the FLSA in that the Labor Code defines “wages” to include vacation pay, holiday pay, sick leave, and severance pay (see Section 61.001(7). Officers and governing persons of Texas employers may therefore be liable to employees if these types of compensation are unpaid, in addition to unpaid minimum wage and/or overtime.

Personal Liability After Nonpayment of Franchise Taxes

Every year, most entities doing business in Texas are required to file a Franchise Tax Return with the Texas Comptroller. Most, but not all, entities are simultaneously required to file a Public Information Report (“PIR”), which discloses to the Secretary of State certain basic information about the entity.

If an entity’s Franchise Tax Return or PIR are not timely filed, then the Comptroller will send out a notice alerting the entity that such item(s) are overdue. Under Section 171.251 of the TTC, the entity has only 45 days after the notice is mailed in which to both file the outstanding items, and to pay the outstanding taxes (plus any late fees). If the entity fails to do so, then the Comptroller will forfeit the entity’s right to do business in the State of Texas (see Section 171.2515 of the TTC). An entity whose right to do business in the state has been forfeited does not cease to exist, and generally these entities will continue to operate normally until the missing tax return(s) and PIR(s) have been filed, and any outstanding taxes and penalties have been paid. Once the missing filings and payments have been made, the Comptroller will automatically reinstate the entity’s right to do business in Texas.

While to the outside world, an entity that has been forfeited by the Comptroller looks no different than it always has, the truth on the inside of the entity is quite different. Section 171.255(a) of the TTC states that “if the corporate privileges of a corporation are forfeited for the failure to file a report or pay a tax or penalty, 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.” (Note that while Section 171.255 of the TTC, and other statutes quoted in this article, refer to corporations, Section 171.2515 of the TTC applies these statutes to any other entity type that is responsible for paying franchise tax.)

In other words, as soon as the Comptroller forfeits an entity’s right to do business in Texas, the officers and governing persons of the entity are each personally liable for any newly incurred debts of the entity. The only exception to this liability is if (i) the officer or governing person objected to the new debt, and was overruled by the other officers or directors, or (ii) the officer or governing person has no knowledge or reason to know of the newly incurred debt.