PAYROLL TAXES AND THE TRUST FUND RECOVERY PENALTY
Employers are required to withhold federal income taxes and Social Security taxes from their employees’ wages pursuant to IRC §3402(a) and IRC §3102(a). These withheld funds are referred to as “trust fund taxes”. When an employer fails to submit withheld trust fund taxes tot eh government, IRC §6672 provides for personal liability on individuals or entities responsible to collect and pay over the taxes. In order to be held liable under IRC§6672, the Service must show two elements:
1. The party being assessed is the person required to collect, truthfully account for and pay over the tax and
2. The party must have “willfully” failed to ensure that the withholding taxes were paid.
Although the statutory provision refers to the liability under IRC §6672 as a “penalty”, this is actually a misnomer. Case law has held that this is in fact not a penalty, but a collection device for the IRS. This statute allows the IRS to “pierce the corporate veil” and to go personally against parties deemed to meet both elements as set forth above. The liability is joint and several, allowing the IRS to pursue multiple parties for all or a portion of the tax involved. However, the IRS will only collect the total liability once.
The trust fund recovery penalty (TFRP) can also be asserted by the IRS when limited liability companies (LLCs) are involved. When the LLC is a disregarded entity, the TFRP is not needed to establish liability against the single member owner, as the single member owner is already the taxpayer for employment tax purposes and is fully liable for all employment taxes, not just the trust fund portion. This same result would happen with a sole proprietorship. If the LLC is classified as a corporation or partnership for tax purposes, the usual procedures for determining responsibility and willfulness apply. Although a partnership under most state laws will provide for full liability of both the trust fund and non-trust fund portions since partners are generally liable for the liabilities of the partnership, under state law, the members of an LLC classified as a partnership are not liable for the debts of the partnership. In these circumstances, the TFRP determination will be made by the IRS and the liability will be limited to the trust fund tax. See IRM §5.7.3.3.1.5.
In reference to the determination of “responsible person”, there is a plethora of case law that addresses this issue. Specific factors that the IRS and courts look at are as follows:
1. Did the individual have an entrepreneurial stake in the business or stock ownership?
2. Did they hold a high position (i.e. officer, director, etc.)?
3. Were they involved in the day to day operations?
4. Did they have the ability to hire and fire?
5. Did they have decision making authority?
6. Did they have control over bank accounts? Signature authority?
7. Were they responsible to prepare and/or sign tax returns?
8. Did they have the ability to sign for loans?
9. Did they have discretion as to which creditors got paid?
These factors are not all inclusive and liability does not require all of the above factors to be present. See also IRM §5.7.3.3.1- Establishing Responsibility.
With regards to the second element of “willfulness”, this has been defined as a voluntary, conscious and intentional act. There is no bad motive requirement. The IRS takes the position that willfulness exists when money withheld from the employees as taxes in lieu of being paid to the government was knowingly and intentionally used to pay operating expenses or for other purposes. See Rev. Rul. 54-158.
In the event the Internal Revenue Service determines that a party is both responsible and willful for trust fund liabilities, the government will mail a 60 Day Notice of Determination. This is a requirement prior to a trust fund tax being assessed. The potentially responsible party has a right to protest the determination. If a protest is filed, the government is required to provide a conference with an IRS Appeals Officer, and an assessment cannot be made until a determination is made by an Appeals Officer that the party is liable. The filing of a protest not only gives an opportunity to contest the proposed assessment, but it prevents interest from running on the trust fund liability, since interest is not accrued until the tax is actually assessed. In the event of an adverse decision by the IRS Appeals Officer, the IRS will assess the tax liability. The targeted individual can challenge the assessment by paying the liability for one employee for one quarter and then pursuing a refund claim with the Internal Revenue Service. In the event the refund claim is denied, the individual then has the right to file a refund action in District Court or the Court of Claims.
In counseling a company facing payroll tax liabilities, a practitioner should be aware of the opportunity to designate voluntary payments to trust fund only. An involuntary payment, one associated with a levy or installment agreement, will be designated by the government, first to the non-trust fund and then to the trust fund liability per quarter. However, if a payment on prior liabilities is voluntarily sent to the IRS, by designating the payment to trust fund, it will be applied in that manner and will more quickly reduce the exposure of the potential responsible parties, usually the officer or shareholders that retained your services. This is a critical strategy which is often missed by accountants and lawyers. Obviously a business that has payroll tax liabilities will often fail, leaving the responsible party holding the bag. If the trust fund liabilities are paid down by designation of payment, this can eliminate the disastrous consequences of the trust fund liability. Unlike income taxes, which often can be discharged in bankruptcy if timed right, trust fund taxes are always a “priority tax” and therefore never dischargeable in a bankruptcy. Therefore, if a responsible person is not a candidate for an offer in compromise, a trust fund liability is devastating.
Bluestein & Muhlbauer, P.C.
333 International Drive
Williamsville, NY 14221
716.633.3200
