Clients Who Owe Payroll Taxes Should Beware Jan. 3by
The CARES Act was passed during the Coronavirus outbreak and among many helpful changes, allowed employers to defer paying part of the payroll taxes until 2021. Though the IRS noted that many employers failed to begin repaying in 2021 as scheduled, it has held off any enforcement for fear of causing more hardship as the economy had not yet rebounded. No longer.
IRS executives have confirmed that January 3, 2022 will ramp back up, including pursuing the responsible, owners, officers and employees for the unpaid trust fund portion of the employment taxes. In short, it appears 2022 is going to get interesting from an enforcement perspective.
IRC § 6672
To protect government revenue derived from payroll taxes withheld from employees, Congress created Internal Revenue Code (“IRC”) § 6672, which allows the Internal Revenue Service to recover the withheld portion of an employee’s payroll taxes, referred to as “trust funds”, from “any person required to collect, truthfully account for, and pay over any tax imposed” and “who willfully fails to collect such tax, or truthfully account for and pay over such tax, or willfully attempts in any manner to evade or defeat any such tax or the payment thereof.”
Trust funds are the portion of the Social Security and Medicare tax withheld from an employee’s pay (7.65 percent) and income tax withheld from the employee’s pay. However, such funds do not include federal unemployment taxes, the employer’s match of the 7.65 percent for Social Security and Medicare taxes, or accrual of interest and penalties of the employer (which often are quite substantial).
The employer is deemed to be holding these funds “in trust” for the U.S. Government, hence the name “trust funds” for that portion of the payroll taxes.
The penalty is referred to as a “100 percent penalty.” This does not mean that the IRS can collect twice as much tax as that withheld by the employer, but rather that the entire amount of the trust funds can be recovered against anyone determined to be a “responsible person” who willfully fails to collect and pay over such tax.
Who is a Responsible Person?
Any and all of the following may be a “responsible person”: sole proprietors, partners, corporate officers, employees, bookkeepers, accounting firms, parent companies, lenders/creditors and purchasing companies.
The term “responsible person” is broad, encompassing anyone responsible for collecting, accounting and paying over taxes to the government. The test is a functional one, focusing on the individual’s or entity’s status, duty, and authority.
The IRS Interview
An IRS Revenue Officer will seek interviews from all potential responsible people he or she can locate. Form 4180 (Report of Interview with Individual Relative to Trust Fund Recovery Penalty or Personal Liability for Excise Taxes) will be used for the interview, and based upon the interview and available documentation, such as bank statements and cancelled checks, the Revenue Officer will seek to assess the trust fund recovery penalty against the individuals or businesses he or she deems responsible.
Those individuals and entities determined to be responsible are jointly and severally liable for the tax (McCray v. U.S., 60 F.3d. 584 (9th Circuit 1995).
Indicators of Responsibility
The following, though not conclusive evidence, are indicators of responsibility:
- Holding corporate office
- Authority in the bylaws
- Hiring and firing authority
- Check-signing authority
- The authority to sign and file payroll returns
Check signing authority alone is not sufficient to establish responsible person status. In fact, if the person had authority but did not sign any checks or payroll tax returns, the absence of a signature can support that individual’s claim he or she is not a responsible party.
The Willfulness Requirement
Though an individual may have failed to collect and pay over trust fund taxes, he or she will not be deemed a responsible person unless the IRS can show the failure to collect and pay over the trust funds was willful. If the failure to collect and pay over the tax was not willful, the individual or entity will not be held personally liable under IRC § 6672.
The IRS’s view, stated in Revenue Ruling 54-158, is that willfulness exists where “money withheld from employees as taxes, in lieu of being paid over to the Government, was knowingly and intentionally used to pay the operating expenses of the business, or for other purposes.” [emphasis added]. The fact that there are insufficient funds to pay both employees and the taxes is not a defense.
In cases where there are not enough funds to pay both the employees and the payroll withholding taxes, the IRS position is that in such a case the employer should prorate the payments so that the employees get a portion of their pay and the IRS obtains the proper amount of withholding for the pay distributed.
Having control over the mechanical disbursements, even if the person does not have the ultimate authority, has been held sufficient control for purposes of IRC § 6672. In Hochstein v. United States the taxpayer was the controller of a corporation that was in financial trouble. An outside lender agreed to advance the money for operations in exchange for the company’s receivables and equipment (Hochstein v. United States, 900 F.2d 543 (2nd Circuit, 1990).
As the company wound down operations, the outside lender reduced its advances, allowing the taxpayer to only pay for the bare essentials, including fuel and net payroll, despite requests to the lender by the taxpayer for sufficient funds to cover the payroll tax deposits. When the IRS pursued Mr. Hochstein personally for the trust fund taxes, he argued that he did not have the ultimate authority to determine whether the funds advanced could be used for the payroll deposits.
The Court held that for a taxpayer to be subject to the liability, it is not necessary for such individual to have ultimate decision-making authority, but rather just have “significant control” over the disbursements. This should be a significant warning to mid-level employees who believe that following a superior’s directives provides immunity from liability.
The Bottom Line
The deferral of enforcement will be coming to an end January 3rd. It would behoove employers to contact the government now and begin making moves to resolve their outstanding issue before they and their family’s personal assets are on the chopping block for IRS collection.
Eric L. Green’s, Esq. is a founding partner at Green & Sklarz LLC. where he focuses on taxpayer representation before the IRS, Department of Justice Tax Division and state departments of revenue. He is a frequent lecturer on tax topics, including handling tax audits and tax controversies. Eric also has the weekly ...