Trust Fund Taxes and Responsible Persons
Trust fund taxes are the amounts withheld from an employee’s pay for income tax, Social Security tax, and Medicare tax and held in trust until paid to the U.S. Treasury. Employers are required to withhold such taxes under Sections 3402(a) and Section 3102(a) of the Internal Revenue Code. If an employer fails to do so, the Internal Revenue Code allows the IRS to collect trust fund taxes from other parties. Under IRC Section 6672, any person who is required to collect, truthfully account for, and pay over such taxes may be assessed a 100% penalty of the unremitted trust fund taxes for the willful attempt to evade or defeat such taxes. The 100% penalty allows the IRS to collect the entire amount of unremitted trust fund taxes. It does not mean the IRS can collect both the unremitted taxes and a penalty equal to such taxes. If a return is filed, the IRS has three years from April 15 or from the date the return was filed, whichever is later, to assess a trust fund recovery penalty. If no return is filed or the return is fraudulent, the statute of limitations never expires.RESPONSIBLE PERSONS
The IRS will attempt to collect trust fund taxes from employers first. If, however, an employer is insolvent, the IRS will identify as many responsible persons as possible to collect unremitted trust fund taxes. A responsible person is “any person required to collect, truthfully account for, and pay over” trust fund taxes. 26 U.S.C. 6672. For purposes of Section 6672, a person “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.” 26 U.S.C. Section 6671. Most courts focus on a person’s duty over his or her job title. As long as he or she “had the authority required to exercise significant control over the corporation’s financial affairs, regardless of whether he [or she] exercised such control in fact,” such person is a responsible person under Section 6672. Purcell v. U.S., 1 F.3d 932, 937 (9th Cir. 1993).
The Supreme Court in Slodov v. U.S., 436 U.S. 238 (1978) held that a person does not need to be capable of carrying out all three enumerated duties (i.e. collect, truthfully account for, and pay over) to be a responsible person. In other words, you can be a responsible person even if you are unable to pay over trust fund taxes to the IRS, but your job requires you to collect such taxes. The Supreme Court further held that a person may be liable for unremitted trust fund taxes incurred before he or she became a responsible person if funds were unencumbered to pay such taxes when he or she assumed control. Funds are unencumbered if there are no restrictions by a creditor senior to the IRS precluding the use of the funds to pay trust fund taxes. A responsible person, however, may “willfully use after-acquired employer funds for purposes other than satisfaction of the trust-fund tax claims” without liability, if the employer has no funds at the time he or she assumes control and “the funds thereafter generated are not directly traceable to collected taxes.” Slodov, 436 U.S. at 259-260.
If the IRS cannot collect from responsible persons, it may impose liability on the employer’s lenders, sureties, and other third parties who lent money to the employer for the specific purpose of paying wages. Under Section 3505(b), such lenders will be liable if they had actual notice or knowledge that the employer does not intend to or will not be able to make timely payment or deposit of trust fund taxes. The liability is limited to 25% of the money lent for wages.
The IRS cannot collect trust fund recovery penalties from employees who are not responsible persons. Furthermore, under IRC Section 1462, employees receive a credit for withheld taxes that have not been paid to the IRS even if the IRS cannot recover the taxes from the employer or other responsible persons.WILLFULNESS REQUIREMENT
For the IRS to collect trust fund taxes from a responsible person, the responsible person must have willfully failed to collect, willfully failed to truthfully account for and pay over, or willfully attempted to evade or defeat trust fund taxes. For purposes of the trust fund recovery penalty, willfulness means a “‘voluntary, conscious and intentional act to prefer other creditors over the United States.’” Phillips v. U.S., 73 F.3d 939, 942 (9th Cir. 1996). It does not require bad motive or ill intent. “[R]eckless disregard of whether the taxes are being paid over, as distinguished from actual knowledge of whether they are being paid over, may suffice to establish willfulness.” Id. For example, a Court may find a responsible person reckless for failing to examine or rectify the issue after receiving notice that the trust fund taxes have not been remitted.
In McClendon v. U.S., a U.S. District Court held that a chief financial officer of a medical practice willfully failed to truthfully account for and pay over trust fund taxes, and therefore, owed the IRS $4.3 million. (DC TX 1/22/2019) 123 AFTR 2d 2019-363. Richard Stephen served as the practice’s CFO from 1995 to 2009. Stephen was responsible for the practice’s finances, including maintaining books and records, filing payroll tax returns, and paying creditors. In 2003, the practice began accumulating tax debt, and by 2009 it owed over $11 million in employee payroll taxes. Stephen, however, informed the Board of Directors that the practice was doing well financially and that all taxes were being paid. The Board later learned that no payroll tax deposits had been made in several years and that Stephen had been stealing money from the practice.
Upon discovering that the payroll taxes were unpaid, the practice stopped paying its creditors and vendors. It also turned over all receivables and its insurance proceeds from the employee theft claim to the IRS. Subsequently, the IRS assessed $4.3 million in trust fund recovery penalties against Stephen and the President of the practice, who filed a refund claim. In response, the IRS filed a counterclaim against Stephen, which resulted in a $4.3 million judgment.PARTIAL PAYMENT ALLOCATION
Employment taxes consist of employers’ share of Social Security and federal unemployment taxes and trust fund taxes that are withheld from employees’ paychecks. If the IRS receives a partial payment for employment taxes as a result of a lawful seizure or levy, the IRS may allocate the payment in any manner it wishes. The IRS usually applies partial payments to an employer’s portion of employment taxes because it can recover such portion from the employer only, unlike trust fund taxes that can be collected from various responsible persons. If a taxpayer voluntarily makes a partial payment and directs the IRS to allocate the payment in a certain manner, the IRS must follow the payor’s instruction.
If you are experiencing issues with employment taxes, do not hesitate to call us at (310) 272-7600. Ben-Cohen Law Firm has experience representing taxpayers with respect to employment taxes and examinations. As a licensed CPA and Board Certified Taxation Law Specialist, our senior attorney Pedram Ben-Cohen has extensive knowledge in tax law. Call us to set up a consultation or fill out our online form.