This article examines the Office of Tax Appeals (OTA) decision in the Matter of the Appeal of B. Wageman, offering insights for tax practitioners regarding the imposition of personal liability for a corporation’s unpaid sales and use tax obligations under California law. This case highlights the critical factors considered by the OTA, particularly the element of willful failure to pay under Revenue and Taxation Code (R&TC) section 6829 and California Code of Regulations, title 18, section 1702.5.

Facts of the Case:

B. Wageman (appellant) appealed a decision by the California Department of Tax and Fee Administration (respondent) denying her petition for redetermination of a June 10, 2015 Notice of Dual Determination (NODD). The NODD sought to hold Ms. Wageman personally liable for $65,991 in unpaid sales tax, plus applicable interest and a $6,616 negligence penalty, incurred by Pit Pro Cycle Inc. (Pit Pro) for the period of January 1, 2010, through December 31, 2012 (liability period). This liability stemmed from Pit Pro’s failure to pay its sales and use tax obligations.

Pit Pro was a closely held corporation, equally owned by Ms. Wageman and her spouse. The company operated a retail store selling motorcycle and all-terrain vehicle repairs, parts, and accessories, and also engaged in some online sales. Pit Pro purchased materials and parts ex-tax and collected sales tax reimbursement from customers on retail sales. However, its sales and use tax returns (SUTRs) for the liability period reported no use tax due.

During the liability period, Ms. Wageman served in various capacities, including president, vice-president, and chief financial officer (CFO) of Pit Pro. She conceded that she was a person responsible for Pit Pro’s sales and use tax compliance during the liability period. She also signed a joint personal guaranty to a vendor, signed Pit Pro’s application for a seller’s permit, filed all quarterly SUTRs from 2Q10 through 2Q13, communicated with the respondent regarding tax matters, signed Pit Pro’s checks, and filed wage and withholding reports.

A significant discrepancy existed between Pit Pro’s reported Cost of Goods Sold (COGS) on its federal income tax returns (FITRs) and its reported taxable sales on its SUTRs. For the liability period, Pit Pro’s taxable sales reported on its SUTRs were $633,391 less than its COGS reported on its FITRs.

In February 2013, the respondent notified Pit Pro of a routine audit. Shortly thereafter, Pit Pro’s directors filed articles of dissolution. Due to a lack of adequate source documentation, the respondent employed a markup analysis to estimate Pit Pro’s taxable sales, establishing an audited markup of 21.86 percent based on a review of sales invoices. Applying this markup to the reported COGS, the respondent determined that Pit Pro had substantially underreported its taxable sales, resulting in a reporting error rate averaging 172.76 percent for 2010 and 2011. Consequently, the respondent determined Pit Pro’s audited taxable sales for the liability period to be $1,112,027, with an underreporting of $704,338. A 10 percent negligence penalty was imposed due to the substantial underreporting and failure to retain adequate records. The Notice of Determination (NOD) issued to Pit Pro became final after the company failed to pay or appeal. Following this, the respondent investigated Ms. Wageman, leading to the issuance of the NODD holding her personally liable under R&TC section 6829.

Taxpayer’s Request for Relief:

Ms. Wageman appealed the NODD, arguing that she should not be held personally liable for Pit Pro’s unpaid tax liabilities. Her central argument was that the respondent failed to prove that she had actual knowledge that Pit Pro’s taxes for the liability period were not being paid at a time when she also had the authority and ability to pay them. She contended that the unpaid taxes were only determined after the audit was completed, long after Pit Pro had dissolved and her authority and ability to pay on its behalf had ceased.

Court’s Analysis of the Law:

The OTA outlined the four conditions that must be met under R&TC section 6829 and California Code of Regulations, title 18, section 1702.5 for an individual to be held personally liable for a corporation’s unpaid sales and use tax, related penalties, and interest:

Termination of Business: The corporation’s business has been terminated, dissolved, or abandoned.
Failure to Remit Collected Tax or Pay Use Tax: The corporation collected and failed to remit sales tax reimbursement or failed to pay use tax on its consumption of tangible personal property acquired ex-tax.
Responsible Person Status: The person against whom the liability is asserted (the responsible person) had control, supervision, responsibility, or a duty to act on behalf of the corporation concerning its sales and use tax obligations.
Willful Failure to Pay: The responsible person willfully failed to pay (or willfully failed to cause others to pay) the corporation’s tax liabilities.

In this case, Ms. Wageman conceded the first three conditions: Pit Pro’s business had ceased, it collected sales tax reimbursement, and she was a person responsible for Pit Pro’s sales and use tax compliance. Therefore, the sole issue before the OTA was whether Ms. Wageman willfully failed to pay (or willfully failed to cause others to pay) Pit Pro’s taxes.

The OTA explained that to satisfy the willfulness requirement, the respondent must demonstrate by a preponderance of the evidence that the failure to pay resulted from an intentional, conscious, and voluntary course of action, citing R&TC section 6829(d) and Cal. Code Regs., tit. 18, § 1702.5(b)(2), (d). Generally, this requires proof of three conditions existing when the taxes were due, as outlined in Cal. Code Regs., tit. 18, § 1702.5(b)(2)(A)-(C):

Actual Knowledge: The appellant had actual knowledge that the taxes were due but not being paid.
Authority to Pay: The appellant had the authority to pay the taxes or to cause them to be paid.
Ability to Pay: The appellant had the ability to pay the taxes, usually determined by reference to the corporation’s available funds, but chose not to do so.

Ms. Wageman conceded the second and third conditions (authority and ability to pay) during the liability period. Thus, the appeal turned on the question of knowledge. The OTA emphasized that when the respondent determines a liability for a past period through an audit, it is not creating the liability but rather identifying the liability that the taxpayer in fact incurred but failed to report.

The OTA further clarified that actual knowledge can be based on circumstantial evidence or evidence of willful blindness, citing Intel Corp. Investment Policy Committee, et al. v. Sulyma (2020) 589 U.S. 178 and Global-Tech Appliances, Inc. v. SEB S. A. (2011) 563 U.S. 754, 769. A person cannot avoid liability by deliberately shielding themselves from clear evidence of critical facts strongly suggested by the circumstances.

Application of the Law to the Facts:

The OTA found Ms. Wageman’s arguments regarding a lack of knowledge unpersuasive. The court highlighted several key pieces of evidence demonstrating her likely awareness of the underreported tax liability:

Ownership and Officer Roles: Ms. Wageman owned 50 percent of Pit Pro and served as its president, vice-president, and CFO.
Responsibility for Tax Compliance: She conceded that she was responsible for Pit Pro’s sales and use tax compliance.
Ex-tax Purchases and Lack of Use Tax Reporting: Pit Pro purchased materials ex-tax and did not report any purchases subject to use tax, indicating that the COGS largely represented items sold at retail.
Significant Discrepancy Between COGS and Taxable Sales: A substantial difference existed between the COGS reported on FITRs and the taxable sales reported on SUTRs for each year of the liability period. The OTA stated that "the evidence shows that appellant was aware of these facts".
Appellant’s Involvement in Financial Matters: Ms. Wageman filed SUTRs, communicated with the respondent, signed checks, and filed wage and withholding reports, indicating her involvement in the financial aspects of the business.
Unchallenged Audit Methodology and Findings: Ms. Wageman did not challenge the validity or accuracy of the respondent’s markup audit method or the resulting findings of substantial underreporting.
Lack of Explanation for Tax Reporting: The record lacked any explanation from Ms. Wageman regarding how Pit Pro’s tax liability was calculated and reported.
Apparent Underreporting: The OTA concluded that "even on the basis of the limited records provided, Pit Pro substantially underreported taxable sales for the liability period, and it is more likely than not that this fact was apparent to appellant".

Based on this evidence, the OTA determined that Ms. Wageman, at a time when she had the authority and ability to pay Pit Pro’s taxes, also had actual knowledge that Pit Pro was not paying its taxes.

Court’s Conclusions:

The OTA held that all conditions precedent to the imposition of personal liability on Ms. Wageman for Pit Pro’s unpaid tax liabilities pursuant to R&TC section 6829 had been satisfied. Consequently, the OTA sustained the respondent’s action denying Ms. Wageman’s petition for redetermination.

Implications for Tax Practitioners:

This case serves as a critical reminder for tax practitioners advising clients, particularly those operating closely held corporations, about the potential for personal liability for unpaid sales and use taxes. The Wageman decision underscores the importance of:

Understanding Responsible Person Status: Clients in management roles with control over financial obligations, especially tax compliance, can be deemed responsible persons.
Monitoring Sales and Use Tax Compliance: It is crucial for responsible persons to have a clear understanding of their company’s sales and use tax obligations and to actively monitor compliance.
Addressing Discrepancies in Financial Reporting: Significant discrepancies between income tax filings (like COGS) and sales and use tax filings (taxable sales) can be a red flag and may be used as evidence of knowledge of underreporting.
Maintaining Adequate Records: The failure to maintain adequate records can lead to indirect audit methods, which may result in significant tax liabilities and penalties.
Seeking Timely Professional Advice: Businesses facing audits or potential tax liabilities should seek professional advice promptly to understand their obligations and potential personal liability.

The Matter of the Appeal of B. Wageman demonstrates that the OTA will consider circumstantial evidence and the overall operational and financial knowledge of responsible persons when assessing the element of willful failure to pay. Tax advisors should emphasize the fiduciary duty of responsible persons to ensure proper sales and use tax compliance to mitigate the risk of personal liability.

Prepared with assistance from NotebookLM.