Tax Case of the Week: Trust Fund Recovery Penalty for a Responsible Person

This week, the Court of Appeals for the 4th Circuit decided a case regarding whether the trust fund recovery penalties were properly imposed against an individual, who was an officer of the corporation that failed to pay over payroll tax, but was not involved with day to day operations, and had officially delegated and entrusted her authority in the corporation to its president.

How this case got to Court

When a company fails to pay its payroll taxes to the IRS may collect from the company itself and/or the individuals responsible for the entity.  However, before the IRS can collect from an individual for delinquent payroll taxes of the entity, it must first make an assessment against the individual.   The Trust Fund Recovery Penalty (26 U.S.C.6672) provides:

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.

Here, the Internal Revenue Service assessed the trust fund recovery penalty (also known as the 100% penalty) against Mrs. Johnson, a corporate officer who had during the time period the payroll liability was incurred by the corporation, had delegated her authority to the president. She then paid a portion of the liability in order to obtain jurisdiction to contest the penalty in court.

District Court Review

On March 30, 2009, the taxpayer filed a suit in District Court seeking a refund of the portion of the penalty that she paid.   The United States, on behalf of the Internal Revenue Service, filed an Answer stating that she was liable as a ‘responsible person’ who had ‘willfully’ failed to pay over withheld payroll taxes and that the burden to prove otherwise fell on the taxpayer.

The District Court held that the taxpayer was a responsible person at the corporation during the relevant quarters even though her participation in the corporation’s affairs was minimal.  Further holding that the taxpayer acted ‘willfully’ in failing to see to it that the outstanding payroll taxes were paid.  The total trust fund recovery penalty assessment was upheld in the amount of $304,995.

Appeal’s Court Review

The intent of the 100%, Trust Fund Recovery Penalty, is to assure compliance by an employer of its obligation to pay employment taxes of its employees by imposing personal liability on individuals associated with the employer/company.

Rule of Law:  Personal liability for a corporation’s unpaid trust fund taxes extends to any person who (1) is ‘responsible’ for collection and payment of those taxes, and (2) willfully fails to see that the taxes are paid. (Plett v. United States, 185 F.3d 216, 218 (4th Circ. 1999)

Who is a Responsible Person

A responsible person is one required to collect, truthfully account for, and pay over any tax (26 U.S.C.6672(a)).  The Supreme Court has interpreted this statutory language to apply to all persons responsible for collection of third party taxes and not only to those persons in a position to perform the duties of collection, accounting for, and paying over. Therefore, a responsible person for purposes of the Trust Fund Recovery Penalty is:

A responsible person for the Trust Fund Recovery Penalty may apply to anyone required to:

    1. Collect, or
    2. Account, or
    3. Remit taxes.

This requirement is determined by analyzing the individual’s effective power and actual authority/ability, by focusing on the individual’s status, duty, and authority within the employer – entity.  This means that “a corporate title alone does not render a taxpayer a ‘responsible person.’ (O’Connor v. United States, 956 F.2d 48 (1992)).   Some of the factors that the court will weigh, include but are not limited to, whether the taxpayer served as an officer of the corporation or a member of its board of directors, controlled the payroll, determined which creditors to pay and when to pay them, participated in the corporation’s day to day management, hired and/or fired employees, possessed check writing authority, etc.

Here, although corporate records and minutes memorialized that the taxpayer had “delegated and entrusted” her authority of the corporation, the Appeals Court held that this was not an effective disclaimer of her authority within the corporation because the taxpayer “had the authority required to exercise significant control over the corporation’s financial affairs, regardless of whether she exercised control in fact.”

The Second prong of the assessment is inquiry into whether or not the taxpayer as a ‘responsible person’ acted ‘willfully’ when payroll taxes were not collected, accounted for, or remitted.

Rule of Law:  Willfulness as an element of Trust Fund Recovery Penalty:  When a responsible person learns that withholding taxes have gone unpaid in past quarters for which he (or she) was responsible, there is a duty to use all current and future unencumbered funds available to the corporation to pay back those taxes.   If a taxpayer thereafter knowingly permits payment of corporate funds to be made to other creditors, a finding of willfulness may be appropriate.   Thus, even when a taxpayer did not act willfully prior to learning of the delinquent payroll taxes, conduct after that point unquestionably evidences willfulness as a matter of law.  (Johnson v. United States, 2013 U.S. App. LEXIS 22444, 2013 WL 5912514 (4th Cir. Md. Nov. 5, 2013)

In this case, the taxpayer did not learn of the delinquency until well after it had been incurred (because she had delegated day-to-day operations and her corporate function to another person).  However, after she became aware of the tax delinquency, she did continue to receive compensation and benefits from the corporation.   The Court held that her receipt of compensation was an intentional preference of other creditors than the United States and thus the willfulness element of the penalty is established.

As such, the Court upheld the penalty assessment.

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