Demystifying the Trust Fund Penalty
In most states, corporations, LLCs and other, similar entities are formed to separate business assets from personal ones. This is done so if a corporation or other entity is sued and a judgment is entered against it, the owners aren’t affected personally. In certain circumstances, the company can go out of business, file for bankruptcy and take other measures to avoid paying. This is true for most debts and judgments. However, this rule does not apply to the non-payment of payroll taxes to the government. In fact, in the most egregious cases, this act can be construed as criminal.
Payroll taxes, specifically FICA, are withheld from an employee’s paycheck, matched by the employer and periodically sent to the IRS. The payments are reconciled quarterly with the actual liability owed versus what is received by the IRS. This is done on Form 941. However, from time to time, businesses have cash-flow issues, and instaed of paying their payroll taxes, they will use the money for other expenses.
Let’s look at a recent case, Myers v. United States, which was heard in Federal Appeals Court. Steven Myers was the CFO and co-president of two companies that failed to pay trust fund taxes. Under 26 U.S.C. § 6672(a), the IRS may recover unpaid taxes against “[a]ny person required to collect, truthfully account for, and pay over any tax” “who willfully fails to collect such tax.” The IRS concluded that Myers was liable under § 6672(a) and assessed the companies’ trust fund penalties against him.
Myers paid some of the penalties and then sued the government for a refund. The government filed a counterclaim for the balance, and both parties moved for summary judgment. The District Court granted a summary judgment in favor of the government.
Here’s the lesson: All employment taxes, except self-employment tax, are trust fund taxes. Here's a quick rundown:
- Federal and State Income Taxes: Withheld from employee pay; the employer doesn't pay. These are reported quarterly on IRS Form 941 and paid to the agency and state revenue department, with the timing based on the amount due.
- FICA Taxes: Withheld from employee pay. The amount taken out will be up to the annual Social Security maximum, with an additional Medicare tax for higher-income employees. The employer pays an equal amount (there is no maximum on the Medicare payment). They are reported quarterly on IRS Form 941 and paid to the IRS, with the timing based on the amount due.
Trust fund taxes are personally assessed against any person(s) who knew that payroll taxes were due and willingly did not pay these to the IRS when required. Those individuals who can be held personally liable include bookkeepers, with signature authority on the company’s bank account, business owners and members of the Board of Directors. If you don’t pay, you may be found guilty of criminal activity, specifically, embezzling money from the US Treasury.
Let’s look at another case. In this one, the CFO worked for two companies owned by a parent one. The parent entity was licensed by the U.S. Small Business Administration (SBA) as a Small Business Investment Company (SBIC). However, it violated the terms of its license, so the SBA sued to put parent into receivership; in other words, it brought someone else in to run the company. As parent's receiver, the SBA replaced the officers and directors and took over its management.
During this time, while the CFO had signature authority over the subsidiary companies' bank accounts, the subsidiaries failed to pay their trust fund taxes. According to the CFO, the SBA's agent told him not to pay the trust fund taxes, but to pay other essential creditors instead.
The Eleventh Circuit held that Code Sec. 6672 applies even when a government agency receiver tells a taxpayer not to remit trust fund taxes to IRS. The CFO conceded that he would be liable for the unpaid taxes if parent's receiver was a private entity. But, he argued, the IRS should be stopped from imposing the penalty on him because he was obeying the instructions of another government agency. The court rejected this argument, holding that the SBA receiver stepped into the shoes of the private entity; therefore, Code Sec. 6672 applied.
In his concurring opinion, Circuit Judge Jordan agreed that the CFO was liable for the penalty, but on the narrower grounds that the taxpayer's reliance on the receiver's instructions was not objectively reasonable. Any officers and agents conducting business under the authority of a US court are subject to all federal taxes applicable to such business as if it were conducted by an individual or corporation.
In addition, the SBA's liquidation procedures require a receiver to make all the appropriate filings with federal tax authorities. Thus, the CFO could not have reasonably relied on the SBA receiver's do-not-pay instructions as a defense to the penalty.
Here’s the takeaway: Payroll taxes are nothing to play around with, so make sure you and your clients are filing them correctly.
Craig W. Smalley, EA is the CEO and Founder of CWSEAPA®, PLLC, located in Orlando, Florida, with clients all over the country in every industry. He has been admitted to practice before the IRS as an Enrolled Agent, and has a Master's Certificate in Taxation from UCLA. He has been in practice since 1994, specializing in individual, partnership...