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A Federal District Court in Idaho recently held that the sole shareholder and president of a company that sold tractors was liable for federal income and social security taxes withheld from the wages of the employees finding that he was a responsible person despite having delegated his authority to a manager who embezzled funds and failed to pay the company’s taxes and that he willfully failed to pay over taxes.[1]

An employer is deemed to hold the withheld taxes “in trust” for the United States and must pay them over to the government on a quarterly basis.[2] The withheld amounts are known as trust fund taxes.[3] If an employer withholds the taxes from its employees but fails to remit them, the government must nevertheless credit the employees for having paid the taxes, and seek the unpaid funds from the employer.[4] Under Code section 6672(a), the IRS may assess a 100% penalty on responsible persons who willfully fail to collect, account for, and pay over the taxes to the United States.[5]

In order for the United States to assess the 100% penalty under section 6672, two requirements must be met: (1) the party assessed must be a “responsible person,” i.e., one required to “collect, truthfully account for and pay over the tax,” and (2) the party assessed must have “willfully refused to pay the tax.”  The individual against whom an assessment is made “bears the burden of proving by a preponderance of the evidence that one or both [of the elements of responsibility and willfulness] is not present.”[6]

Responsible Person. For purposes of section 6672, responsibility “is a matter of status, duty, and authority[.]”[7] “Authority turns on the scope and nature of an individual’s power to determine how the corporation conducts its financial affairs; the duty to ensure that withheld employment taxes are paid overflows from the authority that enables one to do so.”[8] That an “individual’s day-to-day function in a given enterprise is unconnected to financial decision making or tax matters is irrelevant where the individual has the authority to pay or to order the payment of delinquent taxes.”[9] Similarly, delegation of authority to pay taxes will not relieve a person of responsibility. Id. at 936-937 (courts have uniformly and repeatedly rejected the theory that delegation of authority to pay taxes will relieve an individual from responsible person status).

In order to determine whether someone has the authority to pay taxes, and is thus “responsible” under section 6672, courts have looked to a number of non-exclusive factors common in the section 6672 case law, such as whether the taxpayer served as an officer of the corporation or a member of its board of directors, owned a substantial amount of stock in the company, participated in day-to-day management of the company, determined which creditors to pay and when to pay them, had the ability to hire and fire employees, or possessed check writing authority.[10] Not every factor must be present, instead, the Court must consider the totality of the circumstances to determine whether the potentially responsible person had the “effective power” to pay the taxes owed by the company.[11]

Significantly, as more than one person may meet these criteria, “[t]here may be — indeed — there usually are — multiple responsible persons in any company.”[12] The statute “expressly applies to ‘any’ responsible persons, not just to the person most responsible for the payment of taxes.” As such, “[t]hat another person in the company has been delegated the jobs of withholding and generally paying creditors is beside the point.” The “crucial inquiry” is whether a party, “by virtue of his position in (or vis-a?-vis) the company,” could have had “substantial” input into such financial decisions, had he wished to exert his authority. A party “cannot be presumed to be a responsible person merely from titular authority, status as an officer or director is nevertheless material to this determination.”[13]

Willfulness. If a person is deemed a “responsible person,” the next issue is whether that person “willfully” failed to collect, account for, or remit payroll taxes to the United States.[14] A long line of decisions in the Ninth Circuit have defined willfulness “as a voluntary, conscious and intentional act to prefer other creditors over the United States.”[15] In order to satisfy the willfulness prong, “[n]o bad motive need be proved, and conduct motivated by reasonable cause, such as meeting the payroll, may be ‘wilful.'”[16] As the Ninth Circuit has explained:

“If a responsible person knows that withholding taxes are delinquent, and uses corporate funds to pay other expenses, even to meet the payroll out of personal funds he lends the corporation, our precedents require that the failure to pay withholding taxes be deemed  ‘willful.’ This may seem oppressive to the employer and employees, and amount to ‘unwittingly’ willful, which seems an oxymoron, but the proposition is established law.”[17]

After-Acquired Knowledge / Funds. A taxpayer may act “willfully” for purposes of Code section 6672 even though he does not learn about unpaid taxes until after the corporation has failed to pay them.[18] When “a responsible person learns that withholding taxes have gone unpaid in past quarters for which he was responsible, he has a duty to use all current and future unencumbered funds available to the corporation to pay those back taxes.”[19] If the taxpayer instead knowingly permits payments of corporate funds to be made to other creditors, a finding of willfulness is appropriated. “Even assuming . . . that [the taxpayer] did not act willfully prior to learning of the full extent of the tax deficiencies . . ., his conduct after that point unquestionably evidences willfulness as a matter of law.”[20]

In Slodov v United States, the Supreme Court held new management of a corporation is not personally liable for a section 6672 penalty upon using after-acquired revenue to satisfy creditors other than the United States, provided the new management assumes control when a delinquency for trust fund taxes already exists and the withheld taxes have already been dissipated by prior management.[21] The Supreme Court in Slodov based this holding in part:

“[O]n the rationale that to hold a taxpayer personally liable to the extent of after-acquired funds for taxes owed during a time in which he was not a responsible person would be to discourage new investors from attempting to salvage a failing business, which, if the salvage effort were successful, would enable the government to collect more in delinquent taxes than if the business failed.”[22]

In Shore, the District Court noted that “allowing a responsible party to divert after-acquired funds to pay liabilities other than that owed for unpaid payroll taxes would in effect require the federal government to subsidize the corporation’s recovery by foregoing collectible tax dollars.[23] As numerous courts have counseled, ‘[T]he government cannot be made an unwilling partner in a business experiencing financial difficulties.’ ”[24]

Section 6672 can lead to extremely harsh results for individuals involved in corporate entities that fail to pay over amounts withheld from the employees. Company decision makers should carefully review company financial statements and receive assurances that such amounts are being properly remitted to the Government.

[1] William R. Shore v. United States, (No. 1:13-cv-00220) (USDC Idaho; December 4, 2014)

[2] Code Section 7501(a).

[3] Davis v. United States, 961 F.2d 867, 869 (9th Cir. 1992).

[4] Id.

[5] United States v. Jones, 33 F.3d 1137, 1138 (9th Cir. 1994).

[6] See Hochstein v. United States, 900 F.2d 543, 547 (2d Cir. 1990).

[7] Davis, 961 F.2d at 873 (citations omitted).

[8] Purcell v. United States, 1 F.3d 932, 937 (9th Cir. 1993)

[9] Id.

[10] See, e.g., Conway v. United States, 647 F.3d 228, 233 (5th Cir. 2011); Johnson v. United States, 734 F.3d 352, 361 (4th Cir. 2013); United States v. Jones, 33 F.3d 1137, 1140 (9th Cir. 1994).

[11] Erwin v. United States, 591 F.3d 313, 321 (4th Cir. 2010).

[12] Barnett v. Internal Revenue Service, 988 F.2d 1449, 1455 (5th Cir. 1995).

[13] Johnson, 734 F.3d at 361 (4th Cir. 2013)

[14] Code Section 6672(a).

[15] Davis, 961 F.2d at 871

[16] Buffalow v. United States, 109 F.3d 570, 573 (9th Cir. 1997) (citing Phillips v. United States IRS, 73 F.3d 939, 942 (9th Cir.1996); Jones v. United States, 60 F.3d 584, 587-88 (9th Cir.1995); Klotz v. United States, 602 F.2d 920, 923 (9th Cir.1979); Teel v. United States, 529 F.2d 903, 905 (9th Cir.1976)).

[17] Phillips, 73 F.3d at 942

[18] Johnson, 734 F.3d at 364.

[19] Erwin, 591 F.3d at 326.

[20] Id.

[21] Davis, 961 F.2d at 871-72 (citing Slodov, 436 U.S. at 259-60.)

[22] Kinnie, 994 F.2d at 285 (citing Slodov, 436 U.S. at 252-253).

[23] William R. Shore v. United States, (No. 1:13-cv-00220) (USDC Idaho; December 4, 2014

[24] Id. (quoting Thibodeau v. United States, 828 F.2d 1499, 1506 (11th Cir. 1987); see also Mazo, 591 F.2d at 1154 (“[T]he United States may not be made an unwilling joint venture in the corporate enterprise.”).

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