INTRODUCTION
The Internal Revenue Service frequently chooses to pursue collection of a business' unpaid withholding and social security taxes from officers, directors or stockholders of the business via the “Trust Fund Recovery Penalty” provisions of the Internal Revenue Code (“IRC” or “Code”). The popular (though it might be more accurately called the “unpopular”) name by which §6672(a) of the IRC had become known was the “One Hundred Percent Penalty.” As will be seen later, however, it is technically neither 100 percent, nor a penalty. Maybe that's why the IRS renamed it.”
IRC §6672 states, in relevant part, the following:
(a) GENERAL RULE – 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.
§6672(a) first appeared in the Internal Revenue Code of 1954, thought it is substantially similar to §2707(a) of the Internal Revenue Code of 1939. The purpose of this statute was to provide the government with additional parties to go after for the withheld taxes, especially in those cases where it was unable to collect from the corporate entity. To paraphrase one court, the statute was intended to cut through the shield of organizational form and impose liability upon those individuals actually responsible for an employer's failure to withhold and pay over the taxes, U.S. v. Huckabee Auto Co., 46 BR 741; 783 F2d 1546 (1985)
As stated in the first paragraph, the Trust Fund Recovery Penalty is neither 100% nor a penalty. It is 100% in the sense that all of the trust fund taxes imposed by §7501 of the IRC are subject to §6672, but not in the sense of all the unpaid withholding taxes, interest and penalties of the corporation. 26 USC §6672 limits the liability of the responsible persons to liability for the taxpayer – corporation's withholding obligation and does not penalize them for the corporation's liability for its portion of the social security taxes, interest and late payment penalties, First National Bank v. U.S., 591 F2d 1143 (1979).
Likewise, the Trust Fund Recovery Penalty is not a penalty in the punitive or criminal sense; it is, rather, a civil penalty intended merely as a collection tool for the government. As one court put it, the penalty assessed against any person required to collect, truthfully account for, and pay over any tax following the employer's failure to pay income tax and social security withholdings from employee's wages to the Government is not a penalty in any criminal sense, but is civil in nature and is merely a means whereby the Government can collect taxes that the employer withheld and should have accounted for and paid over to the Government, Hartman v. U.S., 538 F.2nd, 336 (1976).
This civil nature of the penalty was codified in §6671(a) of the IRC which states, in relevant part:
The penalties and liabilities provided by this subchapter shall be paid upon notice and demand by the secretary, and shall be assessed and collected in the same manner as taxes…
Having said that, however, it should be noted that – potentially – there is a criminal component to this statute via §7202 of the Code which states, in relevant part:
Any person required under this title to collect, account for, and pay over any tax imposed by this title who willfully fails to collect or truthfully account for and pay over such tax shall, in addition to other penalties provided by law, be guilty of a felony and, upon conviction thereof, shall be fined not more than $10,000, or imprisoned not more than 5 years, or both, together with the cost of prosecution.
The good news – if it can be called such – is that §7202 is not invoked by the Government in the vast majority of the §6672 cases.
WHO IS LIABLE FOR THE TRUST FUND RECOVERY PENALTY?
As stated in the introduction, the IRS frequently chooses to pursue collection of unpaid trust fund taxes from officers, directors or stockholders of the business. They are the people most likely to meet the two-part culpability test that is required by §6672. Distilled to its essence, the two-part test might be succinctly summed up by the two buzz words used by the IRS; i.e.: “willfulness” and “responsibility”.
Stretched out a little bit, this two step analysis to determine liability under §6672 includes determining whether the person was a responsible person within the meaning of §6671(b) and, second, whether the person's failure to collect, account for, and pay over the trust fund taxes was “willful” as defined by the courts.
RESPONSIBLE PERSON
The term responsible person is very broad and includes employees, shareholder, sureties, lenders and others outside the formal corporate organization. The responsible person is any person who can effectively control the finances or determine which bills should or should not be paid and when.
§6671(b) states the following:
(b) PERSON DEFINED – The term “person”, as used in this subchapter, 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.
The courts have identified the responsible person quite broadly. Frequently he was the one with the ability to sign checks on behalf of the corporation or to prevent a check's issuance or to control the disbursement of payments. Godfrey v. U.S., 748 F2d 1568 (1984); Kalb v. U.S., 505 F2d 506 (1974); Gold v. U.S., 671 F2d 492 (1981); Calderone v. U.S., 799 F2d 254 (1986).
Obviously, check-signing authority is only one indicia of responsibility. Other factors which courts have looked to in assessing responsibility were the contents of the corporation's bylaws, the identity of the officers, directors and shareholders of the corporation, the identity of the individual who hired and fired employees, and the identity of the individuals who were in control of the financial affairs of the corporation. Dalof V. U.S., 370 F2d 655 (1966), cert. den. 387 US 906 (1967); Holland v. U.S., 61 AFTR 2d 88-518 (1988).
Significant control over corporate affairs is frequently another test applied by courts to determine responsibility. Indicia of significant control include holding corporate office, authorization to write checks on corporate accounts, control of corporate financial affairs, participating in corporate decision making, holding an equity interest in the business, and possessing any other significant authority such as the ability to hire and fire personnel. U.S. v. Sotelo, 436 US 268, 56 L Ed2d 275, 98 S Ct 1795 (1978); Howard v. U.S., 711 F2d 729 (1983).
Over the years, the courts have come down on both sides of the issue. Some persons were held responsible; while others were not. Frequently it depended on the evidence presented in the particular case. On balance, however, the courts have come down more frequently on holding a person responsible than not. Below are synopses of a few cases that give some indication of just how far some courts have been willing to go to hold a person responsible.
An executive vice president who handled day-to-day operations for a company and had authority to collect and pay over the taxes, but who was ordered by the president and chairman of the board not to remit taxes, was not relieved of his status as a responsible person within the meaning of §6672. Roth V. U.S., 779 F2d 1567 (1986).
An employee of a corporation was found liable as a responsible person even though he discussed delinquent payroll taxes with one of the owners and was told it was none of his business and not to worry about it. The Court reasoned that even though the employee was not an officer, he was responsible for the ordinary day-to-day administrative operating functions of the business with authority to determine which creditors would be paid. Gephart v. U.S., 820 F2d 761 (1987).
An individual acting through a power of attorney for a corporation that had failed to pay withholding taxes was a responsible person even though the corporate comptroller actually signed over checks and prepared all the corporation's financial statements. Godfrey v. U.S. 748 F2d 1568 (1984), rev'g 3 Cl Ct 595 (1983).
WILLFULNESS
Willfulness is not defined by the Code for purposes of §6672(a). Consequently, the courts have fleshed out the term through their decisions. In the context of §6672(a), willfulness has been defined as the voluntary, conscious and intentional act of preferring other creditors over the United States. Teel v. U.S., 529 F2d 903 (1976).
The term willfully does not require a criminal or other bad motive on the part of the responsible person, but simply a voluntary, conscious or intentional failure to collect, truthfully account for, and pay over taxes withheld from the employees. Bowen v. U.S., 88-1 USTC (1988).
Willfulness does not require a finding of attempt to defraud or to deprive the United States of taxes. It requires only that the choice to pay funds to other creditors instead of the Government be made voluntarily, consciously, and intentionally. Gefen v. U.S., 400 F2d 476 (1968).
The Seventh Circuit has noted that whereas in criminal statutes willfulness generally requires bad purpose or the absence of any justifiable excuse, these elements need to be present in civil actions. Rather, willful conduct denotes intentional, knowing and voluntary acts. Monday v. U.S., 421 F2d 1210 (1970), rev'g and remanding 294 F Supp. 1394 (1969).
Some courts have gone so far as to state that failure to make the monthly deposits required by Regulations is sufficient to show willfulness. Barnett v. U.S., 594 F2d 219 (1979), aff'g in part, rev'g in part 76-1 USTC ¶9449 (1976); Brown v. U.S., 591 F2d 1136 (1979).
THIRD PARTY LIABILITY
Besides the Trust Fund Recovery Penalty provision of §6672(a), liability may also be imposed for non-payment of withholding taxes on parties under §3505 of the IRC. Unlike §6672(a) however, §3505 imposes liability not on a responsible person of the corporation, but on third parties who make either direct payment of wages to the taxpayer's employees or who make advances to pay the taxpayer's employer. Examples of such third parties include lenders, sureties or other third parties.
§3505 has two distinct provisions: §3505(a) and §3505(b). §3505(a) imposes liability on lenders, sureties or persons other than the employer who pay wages directly to the taxpayer's employees.
§3505(a) states, in relevant part:
(a) DIRECT PAYMENT BY THIRD PARTIES – if a lender, surety, or other persons, who is not an employer under such sections with respect to any employee or group of employees, pays wages directly to such an employee or group of employees, employed by one or more employers, or to an agent on behalf of such employee or employees, such lender, surety, or the person shall be liable in his own person and estate to the United States in a sum equal to the taxes (together with interest) required to be deducted and withheld from such wages by such employer.
The liability is equal to the taxes (plus interest) that the employer is required to withhold from such wages. U.S. v. Fred Arnold, Inc., 573 F2d 605 (1978); U.S. v. Kennedy Construction Co. of NSB, Inc. 572 F2d 494 (1978). Moreover, the liability under §3505(a) is imposed regardless of whether the payor knows that the employer does not plan to pay the withheld taxes.
Section 3505(b), on the other hand, imposes liability on a lender, surety or person who supplies funds to an employer for the specific purpose of paying wages if the payor has actual notice or knowledge that the employer does not intend to will not be able to make a timely deposit of the withheld taxes.
§3505(b) states the following:
(b) PERSONAL LIABILITY WHERE FUNDS ARE SUPPLIED – If a lender, surety, or other person supplies funds to or for the account of an employer for the specific purpose of paying wages of the employees of such employer, with actual notice of knowledge (within the meaning of section 6323(i)(1)) that such employer does not intend to or will not be able to make timely payment or deposit of the amounts of tax required by this subtitle to be deducted and withheld by such employer from such wages, such lender, surety, or other person shall be liable in his own person and estate to the United States in a sum equal to the taxes (together with interest) which are not paid over the United States by such employer with respect to such wages. However, the liability of such lender, surety, or other person shall be limited to an amount equal to 25 percent of the amount so supplies to or for the account of such employer for such purpose.
The payor is required to exercise due diligence in determining the relevant facts before the lack of actual notice of knowledge will constitute a defense. Under §3505(b), the payor does not have an affirmative duty to investigate the employer's intent, U.S. v. Coconut Grove Bank, 545 F2d 502 (1977). However, there is a duty to investigate when suspicious circumstances exist, U.S. v. Metro Construction Co., Inc. 439 F. Supp. 308 (1977) rev'g in part, 602 F2d 879 (1979).
In general, ordinary working capital loans to the employer do not result in §3505(b) liability even when the payor knows that some of the funds advanced may be used to pay wages in the ordinary course of business. An ordinary working capital loan is one which enables the employer to meet current obligations as they arise.
The payor is not required to ascertain how the funds will be used. Nevertheless, when the loan payor has actual notice or knowledge that the proceeds of the loan are to be specifically used to pay net wages, §3505(b) can apply. Treas. Reg. §31.3505-1(b)(3).
It should also be noted that if the payor exercises substantial control over the employer's financial affairs and the payment of wages, a third basis for liability may apply. The payer may be found to be the “employer” and be held liable as such for all the employment taxes. U.S. v. Callahan, 75-2 USTC ¶9612 (1975).
PROCEDURE FOR ASSERTION OF THE TRUST FUND RECOVERY PENALTY
The revenue officer charged with the case has the duty to gather evidence to establish willfulness and responsibility. To that end, he/she will summons bank records (such as cancelled checks, signature cards and corporate resolutions), interview potentially liable persons and secure corporate records, such as tax returns, articles of incorporation, etc. See Exhibit 5601-1 of the Internal Revenue Manual (“IRM”).
Once a determination is made to pursue assessment against a particular individual, IRS will mail a notice of proposed assessment (IRS Letter 1153) to the individual, together with IRS Form 2751, Agreement to Assessment. The individual has 30 days in which to lodge an appeal. If he fails to respond with a request for appellate review, the penalty will be assessed without a hearing.
To lodge an appeal, the individual must do so in writing (if the amount of the proposed tax is more than $2,500) and state clearly his grounds for appeal. The grounds must include factual and legal arguments. See IRM Exhibit 5600-3.
A hearing will be held by the Appellate Office to consider the taxpayer's arguments. If, after the hearing, the taxpayer and the IRS cannot agree, the taxpayer's only recourse is to wait for the IRS to assess the tax against him, pay it (or a divisible portion of it), and file a claim for a refund. If only a divisible portion of the tax is paid (such as one employee's tax for one quarter of the corporation's unpaid tax liability), the taxpayer has the additional requirement of posting a bond. See IRC §6672(b) and IRM 5755.2
The claim for a refund is filed on IRS Form 843. It must be filed within 30 days after notice and demand for payment in order to legally preclude the IRS from pursuing collection against the claimant. After 30 days, IRS' collection efforts are discretionary. In any event, the claim must be filed within 2 years after the tax (or divisible portion of it) is paid. Thereafter, the statute for filing a claim for a refund expires. See IRC §6511(a).
IRS has six months of exclusive jurisdiction to act on the claim administratively. Thereafter, the taxpayer has jurisdiction to sue the government in a U.S. District Court or the Court of Claims in Washington, D.C. If the IRS denies the claim within its exclusive six months or, in any case, before the taxpayer brings a suit, the taxpayer must file a suit within 30 days after the claim is denied. Failure to do so in that time frame entails the risk of having IRS pursue enforced collection. See IRC §6672(b)(2).
STATUTE OF LIMITATIONS
It should be noted that the IRS has 3 years from the later of the succeeding April 15th or from the date the return was filed to assess the Trust Fund Recovery Penalty against the responsible person. See IRM Exhibit 5600-2. For example, if the corporation files a 941 tax return for the period ended 9/30/90 by 10/31/90, the IRS has until 4/15/94 to assess the penalty against the responsible person for any unpaid trust fund taxes still outstanding for that quarter.
This assessment statute may be extended several ways:
a) by waiver, IRC §6501(c)(4);
b) through bankruptcy, IRC §6503(i); or
c) by absence from the U.S., IRC §5503(c).
The assessment statute is not extended by the target person filing an appeal, or by the corporation filing bankruptcy.
There is no statute of limitations for unsigned or fraudulent returns or those prepared by the IRS under IRC §6020(b). See IRC §6501(c) and IRC §6501(b)(3).
COLLECTION ISSUES
Once the tax has been assessed against the responsible person and any appeal and/or litigation has been exhausted, he must deal with the Collection Division of the IRS. While a discussion of all the possible collection issues that may be encountered by the taxpayer is beyond the scope of in this article, several relevant issues are worth noting:
(a) The IRS is not required to pursue collection of the unpaid withholding taxes from the corporation before attempting to assert 100% Penalty against responsible officials of the corporation, Bowen Industries v. U.S., 61 BR 61 (1986); U.S. V. Huckabee Auto Co., 783 F2d 1546 (1986). The IRS frequently pursues collection of 100% Penalty from the responsible officials even if the corporation is functioning and even if the corporation is making payments on the delinquent withholding taxes pursuant to a payment agreement with the IRS.
b) The IRS can, and frequently does, pursue collection of the Penalty against more than one responsible person, U.S. Life Title Insurance Co. of Dallas v. Harbison, 784 F2d 1238 (1986). However, IRS can retain only the amount equal to the employer's trust fund taxes, together with interest, U.S. v. Solelo, 436 U.S. 268 (1978); Otte v. U.S., 419 U.S. 43 (1974), IRS Policy Statement P-5-60.
c) If the Penalty is fully paid by one responsible person, the assessments against any others will not be abated until after the two year statute of limitations for a refund has expired against the person that paid. See IRM §5638.1(7)(b) and Hanshaw v. U.S. 87-1 USTC 9248 (1987). In fact, collection procedures may be undertaken against a second responsible person in some cases even if the first responsible person has paid all of the Penalty. IRS asserts that it may do so if the collection statute is about to expire against the second persons and he refuses to sign a waiver. See IRM 5638.1(11) and (12).
d) No Federal common-law right to indemnity or contribution for a tax liability assessed against a responsible person exists under §6672, Sinder v. U.S., 655 F2d 729 (1981); Continental Illinois National Bank and Trust Co. of Chicago v. U.S., 60 AFTR 2d 87-5163 (1987);
e) The IRS is under no obligation to credit the taxes collected by levy in any particular manner to suit the corporation or to minimize the liability of the responsible person, Pike v. U.S., 723 F2d 233 (1983). However, any voluntary payments made by the corporation may be designated to the trust fund taxes, Quinton v. U.S. 89-1 USTC §9270 (1989); IRM 5634.12(2).
BANKRUPTCY ISSUES
The first thing that should be noted is that IRC §6672 taxes are not dischargeable in bankruptcy. See §§523(a)(1)(A) and 507(a)(7)(C) of the Bankruptcy Code. Thus any individual against whom the 100% Penalty has been assessed has no hope of discharging it through bankruptcy.
Nor does the filing of bankruptcy by the corporation stay the IRS from attempting to assess the Penalty against the responsible person, Quattrone Accountants, Inc. v. IRS, 895 F2d 921 (1990); American Bicycle Association v. U.S., 90-1 USTC §50,104 (1990). The U.S. Government has prevailed on this issue on jurisdictional grounds as well as through §7421 of IRC (anti-injunction statute).
However, the Chapter 11 corporations may propose a plan that requires any payments of the corporation to the IRS to be applied to the trust fund taxes first. In U.S. V. Energy Resources Co. Inc., 110 S.Ct. 2139 (1990) the court held that, even though the payments through Chapter 11 bankruptcy could not be considered voluntarily, the bankruptcy court had authority under §105 of the Bankruptcy Code to designate payment to the trust fund taxes if it felt that such designation would help the debtor's reorganization efforts.
The Supreme Court specifically declined to rule on the issue of whether such designation could be made in a Chapter 7 case. The lower courts have consistently held, however, that such designation is not allowed, In re: F.A. Dellastatious, Inc., #83-10240-A (Bank Ct. E. Va. – 1990).
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