Delinquent Payroll Taxes and the Trust Fund Recovery Penalty
Can officers and directors of a corporations be held personally liable for delinquent payroll taxes? Yes, they can.
If you currently are or are considering becoming a corporate officer or director, you should be aware of the possibility of personal liability for unpaid employee withholding taxes. Under the tax laws of this country (i.e., the Internal Revenue Code), employers are required to collect (through withholding) certain taxes from their employees, the taxpayers. The withheld sums are commonly referred to as ‘trust fund taxes,’ reflecting the Code’s provision that such withholdings or collections are deemed to be a ‘special fund in trust for the United States.’
The employer is required to pay over these “trust fund taxes” to the government and is liable for the amount of taxes which should have been paid. In addition, the Code allows the government to recover any amounts not paid by the employer by assessing a penalty against those persons within the employer corporation who are deemed responsible for the failure to pay the trust fund taxes to the government.
- Internal Revenue Code (IRC) § 6672(a) provides, in pertinent part, 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 or the payment thereof, shall, in addition to other penalties provided by law, be liable to a penalty equal to the total amount of the tax evaded, or not collected, or not accounted for and paid over.
- Further, I.R.C. § 6671(b) states as follows:
- The term “person,” as used in this subchapter [including § 6672(a) above], includes an officer or employee of a corporation, or a member or employee of a partnership, who as such officer, employee, or member is under a duty to perform the act in respect of which the violation occurs.
From these two statutory provisions, it is clear that, in order to be found liable for a trust fund recovery penalty, an individual must have: (1) been “under a duty” to collect, truthfully account for, and pay over trust fund taxes; and (2) willfully failed to do so or willfully attempted to evade or defeat payment of the tax.
A person is deemed responsible, and therefore “under a duty,” under Section 6672 if he retains sufficient control of corporate finances that he can allocate corporate funds to pay the corporation’s other debts in preference to the corporation’s withholding tax obligations. Responsible persons include all “persons so connected with a business as to be in a position to exercise full authority over financial affairs,” and thus, are not strictly limited to those holding formalized positions within a corporation or partnership.
- The Federal Claims Court has stated:
- “(T)he fact-finder must look for those individuals who had “the power to control the decision-making process by which the employer corporation allocates funds to other creditors in preference to its withholding tax obligations.” Stated slightly differently, a responsible person is one “with ultimate authority over expenditure of funds.” This is necessarily a fact-intensive inquiry, and the courts have generally focused on those facts bearing on an individual’s “status, duty, and authority” within the employer corporation.
- Ghandour v. U.S., 36 Fed.Cl. 53 (Fed.Cl. 1996) citations omitted.
In making the responsible person determination, “[t]he crucial inquiry is whether the person had the effective power to pay the taxes–that is, whether he had the actual authority or ability, in view of his status within the corporation, to pay the taxes owed.” Taylor v. IRS, 69 F.3d 411, 416 (10th Cir. 1995). While corporate office alone is not enough to render an individual responsible person status within the scope of Section 6672, individuals who have the authority and/or ability to pay taxes will be deemed responsible.
The second element required for liability is willfulness. Willfulness may be shown in at least two ways: (1) a deliberate choice voluntarily, consciously and intentionally made to pay other creditors instead of paying the government or (2) reckless disregard of a known or obvious risk that the taxes may not be remitted to the government.
With respect to the second method of proving willfulness, courts have established three distinctive fact patterns from which to infer a reckless disregard sufficient to demonstrate willfulness under Section 6672. Finley v. United States, 123 F.3d 1342 (CA10 1997).
First, courts have held that reliance upon the statements of a person in control of corporate finances may constitute reckless disregard when the circumstances show that the responsible person knew the person making the statements was unreliable. This requires a finding that the responsible person had knowledge that the other individual had in the past failed to perform adequately with regard to the financial affairs of the taxpayer entity. An example of such a case is United States v. Leuschner, 336 F.2d 246 (CA9 1964). In Leuschner, the defendant knew that the person on whom he relied had failed in the past to pay the company taxes and had preferred other creditors. Because the Leuschner defendant did nothing to insure that this did not happen again, the court found him to have met the willful requirement.
Second, courts have held that willful conduct includes failure to investigate or to correct mismanagement after having notice that withholding taxes have not been remitted to the Government. This requires a finding that the responsible person had ‘notice’ that the taxes had not been remitted in the past.
Third, courts have found that when a responsible person continues to pay other bills knowing that the business is in financial trouble, he willfully violates Section 6672 if he fails to make reasonable inquiry as to whether money would or would not be available for payment of the taxes when they became due.
In cases where trust fund taxes are not paid, the IRS takes an aggressive stance as to whom it deems responsible. The IRS makes serious efforts to impose liability and collect unpaid trust fund taxes from individuals it considers responsible. While the IRS must establish that a person was both under a duty to collect and willfully failed to pay withholding taxes in order to establish personal liability, individuals who consider themselves innocent bystanders are often found liable.
William A. Robinson is no longer with Frascona, Joiner, Goodman and Greenstein, P.C., a Colorado law firm.