An Interesting Trust Fund Recovery Penalty Case – and Some Further Musings on “Willful” By Robert S. Horwitz
The Fifth Circuit recently reversed summary judgment in favor of the Government in a $4.3 million trust fund recovery penalty (“TFRP”) case. McClendon v. United States, Dkt. No. 17-20174 (June 14, 2018), at http://www.ca5.uscourts.gov/opinions/pub/17/17-20174-CV0.pdf The TFRP, Internal Revenue Code §6672, allows the IRS to assess against any person responsible any withholding tax that was not collected, accounted for or paid over to the IRS, including income and social security tax withheld from employees’ wages.
The taxpayer, Dr. McClendon, founded a medical association that grew large enough to hire a CPA, Richard Stephen, as CFO in 1994. Stephen regularly reported to the board that the association was doing well financially and that its tax obligations were being met. Stephen had, in fact, been embezzling funds from the association.
In May, 2009, the board learned from the IRS that 23 quarters of employment taxes were not paid and that the association owed over $11 million in payroll taxes. On the advice of counsel, the association turned over to the IRS all its receivables. It also remitted to the IRS a $250,000 insurance recovery and made payments to the IRS of an amount equal to the balance in its account in May 2009. Dr. McClendon loaned $100,000 to meet the association’s final payroll.
Stephen was convicted of felony theft in state court and sentenced to ten years imprisonment. The IRS assessed a $4.3 million TFRP against both Dr. McClendon and Stephen. McClendon paid a nominal amount toward the assessments, filed a refund claim and sued for a refund. The Government counterclaimed against Dr. McClendon and joined Stephen as a counterclaim defendant. After discovery, the Government moved for summary judgment, which the district court granted. Dr. McClendon moved for reconsideration, arguing that based on his declaration, deposition testimony, and copies of checks, he established that all available funds were used to pay tax after he learned of the liability. The Government opposed the motion on procedural grounds; it also claimed that Dr, McClendon was required to give a full accounting of all available funds from the time he learned of the tax liability. The district court denied the motion.
The Fifth Circuit reversed, holding that McClendon produced sufficient evidence to raise an issue of material fact as to whether all available funds were used to pay the IRS after he learned of the tax liability. There was both a concurring and a dissenting opinion.
So what leads to musings on “willful?” In both the district court and the Fifth Circuit the Government argued that Dr. McClendon was grossly negligent in failing to properly supervise Stephen, and thus his failure to collect, account for and pay over tax was willful. The concurring opinion notes:
First, I don’t see how, under the circumstances before us, the district court could rule on now-deceased Dr. McClendon’s “reckless” disregard of his tax duties as a matter of law. Given that he and his partners employed Stephen for a decade before the CPA started embezzling, their reliance on his handling of their business affairs seems at least plausible. Second, it takes some chutzpah for the IRS, which submitted 285 pages of exhibits including FPA business records in support of summary judgment, now to assert McClendon did not bear “his” burden to articulate precisely how those records demonstrated whether there were insufficient funds to cover the unpaid withholding taxes and whether all available receipts were in fact paid to the IRS. Is it too much to assume the tax collectors can read bank and financial records adeptly, and that ethically, they wouldn’t make claims without factual foundations of which they ought to be aware? To challenge the legal consequences of McClendon’s $100,000 cash infusion is one thing; to claim, in the face of his sworn affidavit and documents, and their own access to corroborative financial records, that this isn’t enough to raise a fact issue is irresponsible at best. Slip Op. at 17.
Traditionally, to establish willfulness the Courts have required that “the responsible person acts with a reckless disregard of a known or obvious risk that trust funds may not be remitted to the Government, *** such as by failing to investigate or to correct mismanagement after being notified that withholding taxes had not been duly remitted.” Mazo v. United States, 591 F. 2d 1151, 1154 (5th Cir. 1979); see also, Leuschner v. United States, 336 F.2d 246 (9th Cir. 1964); Kalb v. United States, 505 F.2d 506 (2nd Cir. 1974) (rejecting Government claim that “should have known” is sufficient to establish willfulness); Godfrey v. United States, 3 Ct. Cl. 595 (1983); Calderone v. United States, 799 F.2d 254 (6th Cir. 1986).
Despite the requirement for at the very least “reckless disregard” the Government has been pushing for the Courts in FBAR willful cases to hold that signing a return with the box on Schedule B checked no is automatically willful with some success. Recently, in Kimble v. United States, Ct. Fed. Cl. Dkt 1:17-cv-00421, the Government moved for summary judgment on the ground that Ms. Kimble had constructive knowledge of the contents of the return and thus her failure to file an FBAR was willful. The Government lost a similar motion recently in Norman v. United States, another Court of Federal Claims case, but that doesn’t deter the Government from its quest to minimize its burden of proving willful.
Speaking of the FBAR penalty, on June 1, 2018, the Government filed a post-trial brief in Norman on the validity of the Treasury Regulation that limits the maximum willful penalty to $100,000. The Government’s position is that the regulation is outdated, that the 2010 amendment that contains the regulation was not meant to be a substantive change. It was merely a reorganization of the Bank Secrecy Act regulations and “not an exercise of the Treasury Secretary’s rulemaking” and that the Court should accept as controlling the Government’s interpretation of its own regulation, i.e., that the 2010 regulation was superseded by the 2004 amendment to 31 USC §5321. I guess the Treasury Department’s promulgation of the regulation in 2010 was not “willful.”
Robert S. Horwitz – For more information please contact Robert S. Horwitz – firstname.lastname@example.org or 310.281.3200 Mr. Horwitz is a principal at Hochman, Salkin, Rettig, Toscher & Perez, P.C., a former Assistant United States Attorney of the Tax Division of the Office of the U.S. Attorney (C.D. Cal) and represents clients throughout the United States and elsewhere involving federal and state, administrative civil tax disputes and tax litigation as well as defending criminal tax investigations and prosecutions. Additional information is available at http://www.taxlitigator.com.