A distraught woman – we'll call her Mrs. Smith – called us recently with an emergency. IRS had seized¹ her mother's farm in Wisconsin, she said, and was preparing to sell it² She said they needed help urgently and asked if we could get involved.
Further discussion with Mrs. Smith revealed additional details. Ten years ago IRS assessed approximately $200,000.00 against the mother based on unpaid payroll tax liabilities of a restaurant owned and operated by her husband, Mrs. Smith's father, who had since died. Mrs. Smith said that IRS was now trying to collect the debt by seizing and selling the farm, which was valued at $800,000.00.
Mrs. Smith went on to explain that her mother had also signed a contract to sell a parcel of the farm to a buyer who was paying the mother $1,800.00 per month until he could get financing to complete the sale. As part of its enforcement action, the IRS had also served a levy³ on the contract purchaser and was receiving the $1,800.00 in monthly payments intended for the mother. Additionally, IRS had levied on her 70 year old mother's Social Security benefits⁴ so that she was left with no money to live on, other than her income from a part time job as a restaurant hostess. Finally, IRS had filed a lien⁵ on the mother's home in Illinois.
We suggested to Mrs. Smith that she come in as soon as possible and bring us all the relevant documents from the IRS, as well as financial information about the mother. We needed to review the facts and act as quickly as possible. Obviously, the situation had become critical.
Mrs. Smith and her husband appeared in our office the next morning. A review of the documents brought in by Mrs. Smith confirmed the facts disclosed in the telephone conversation. They also revealed that the tax liability assessed against the mother (as well as her deceased husband), was the so-called “trust fund recovery penalty⁶” from payroll tax liabilities of a restaurant the husband owned before he became ill and died.
After the father died, IRS attempted to collect the money from Mrs. Smith's mother. Mrs. Smith retained a tax attorney to deal with the IRS. The tax attorney devised a strategy to basically ignore the IRS. His reasoning was that the collection statute, which legally expires ten years after the tax is assessed⁷, was about to expire and the mother should just wait them out. What the tax attorney failed to take into account, however, was that IRS could – and did, in fact – take enforcement action before the statute expired. More importantly, he failed to realize that IRS could legally sell the farm after the collection statute expired, as long as the seizure was made timely⁸.
The tax attorney's fatal flaw notwithstanding, a strategy was needed to salvage the situation. Further inquiries revealed that the mother's deceased husband basically ran the restaurant as a one-man operation. He made all the decisions, hired and fired employees, signed all the checks, paid all the bills, ordered supplies, etc. When he became seriously ill, the restaurant continued to operate, but many of the things the husband used to do, including make federal tax deposits and pay the payroll tax liabilities, didn't get done. As a result, the restaurant ran up significant payroll tax liabilities. IRS attempted to collect the taxes due from the restaurant, but was only partially successful. It then assessed part of the tax liability (the “trust fund” portion) against the husband personally, as well as his wife. When the husband died, they pursued collection against his wife.
When questioned further, the daughter revealed that, even though her mother was technically the Secretary of the corporation, in reality she did little other than work as a hostess at the restaurant. She greeted the customers and seated them at their tables. She didn't sign any checks, didn't prepare any tax returns, and made no significant financial or accounting decisions. Based on IRC 6672 and the relevant case law, it appeared that she shouldn't have been held personally liable for the unpaid payroll tax liabilities.
But theory and practice don't always coincide. First, the mother should have challenged the assessment against her when it was first proposed by the IRS ten years ago. She would have received a letter from the IRS and would've had 60 days to file a protest. But that 60-day window of opportunity had long since expired. The IRS now had a valid tax assessment against the mother and could legally pursue collection against her assets and income until the assessment was reversed, or the collection statute expired. Second, the IRS wasn't in a mood to listen to theoretical arguments after the “wait them out” strategy of the previous attorney, and after they'd done a lot of work to enforce collection of the tax liability against the restaurant, the deceased husband, and the mother.
After giving it some thought, we decided on a two-part strategy. First, we would attempt to get the assessment against the mother abated using the standard administrative procedures available in such a case. One such procedure was to file a Form 843, requesting a refund of the money taken based on the argument that the assessment against the mother was invalid. (IRS had already collected about $30,000.00 over the years from various levies on the mother's bank accounts and the refund request would be for any money taken from the mother within the last two years.) If a refund was denied, or no response was received within six months, we had jurisdiction to sue the U.S. Government in the U. S. District Court⁹
Second, we would prepare to file bankruptcy, either Chapter 11 or Chapter 13, if IRS failed to stop the sale of the farm prior to making a decision on the refund request. We knew that filing a bankruptcy petition would give us two powerful weapons: the automatic stay of Sec. 362¹⁰, which would stop the IRS from selling the farm, and Sec. 505¹¹, which gives the Bankruptcy Court jurisdiction to determine the validity of any tax liability, or additions thereto.
We filed a Form 843 immediately with the IRS and gave Mrs. Smith the bankruptcy questionnaire to start working on. We also attempted to get more facts and/or documents to buttress our arguments. Unfortunately, neither Mrs. Smith nor her mother had any documents from the defunct restaurant (corporate resolutions, bank signature cards, cancelled checks, etc.), to show that the mother had little relevant authority. We contacted the IRS in an effort to get the same documents. We had our doubts that IRS would have any of them either because of how much time had lapsed since the assessment was made against the mother.
We didn't get very far initially with the collection enforcement people, but we were lucky to get hold of a technical adviser at IRS who tracked down the original trust fund recovery file. She found that it contained no evidence to support the argument that the mother was a responsible official of the restaurant who willfully failed to collect and pay the payroll taxes of the restaurant. Faced with the possibility of having to sustain IRS' case in the U.S. District Court, the technical adviser and her manager agreed to abate the tax assessed against the mother. Furthermore, she released the seizure of the farm, the levy against the contract purchaser of the parcel of the Wisconsin farm, the levy on the mother's Social Security benefits, and the lien against her home in Illinois. She also agreed to refund any money taken from the mother's bank accounts in the last two years.
It's not always that IRS stories such as this one end so happily.