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Fail to Remit Withheld Taxes and Find Yourself in a World of Hurt

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Jan 12th 2015
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Employers know they must withhold Social Security and income taxes from their employees' paychecks. And the employees understand this has to happen, even if they don’t particularly like it. But that's only half the story: Once the funds have been withheld, they have to be remitted to the federal government. Some companies, especially smaller ones, tend to forget this—and that takes them to a very bad place.

The problem has its roots in the businesses' needs to come up with sufficient funds to meet the gross payroll and also pay any apprehensive suppliers that are unwilling to extend additional credit. Their solution is what gets these businesses into bad tax trouble: Management opts to pay employees their net salaries or wages and not to make the required deposits with the IRS. After all, rationalize these ever-optimistic honchos, the "borrowed" taxes can be taken care of just as soon as business picks up.

Business owners may not think they’re doing something dishonest by dipping into the withholding kitty to make up a temporary cash shortfall. But many thousands of individuals who’ve played games with withheld taxes have been stunned to discover that their outfit’s failure to pay such taxes made them personally liable—and that the IRS could grab funds in their bank accounts and retirement plans or seize other personal assets. They learned the expensive way that Code Section 6672 authorizes the IRS to assess a penalty equal to 100 percent of the amount due against the people who are responsible for collecting or paying withheld taxes and who “willfully” fail to collect or pay them.

Who are “responsible persons”? Usually, those who decide which creditors to pay and when. They’re also jointly liable for the entire amount owed. So even if they can establish that others were more responsible for the collection, accounting and payment of the missing taxes, their liability in no way lessens.

Not surprisingly, the IRS defines responsibility quite liberally. Responsible persons include:

  • Officers or employees of corporations.
  • Members or employees of partnerships.
  • Corporate directors or shareholders.
  • Members of boards of trustees of nonprofit organizations.
  • Other individuals with authority and control over funds to direct their disbursement.

Also not surprisingly, the IRS and the courts set the bar low when they define willfulness: It only requires a conscious, voluntary act, not intent to defraud. Nor need the act be one of commission. The willfulness requirement also can be met when there’s an act of omission, such as when a person fails to investigate or correct mismanagement after noticing that taxes are due and other creditors have been paid. Note, too, that personal bankruptcy does not relieve an individual of responsibility for his or her company's failure to pay withheld taxes.

Who gets stuck. Generally, the feds pursue the owners or top officers of organizations. The official policy is not to assert the penalty against "non-owner employees of the business, who act solely under the dominion and control of others, and who aren’t in a position to make independent decisions on behalf of the business entity." Employees in this grouping include secretaries, clerks and bookkeepers.

Help for volunteers. A law change enacted in 1996 confers protection on people who serve as unpaid members of boards of schools, museums and other tax-exempt groups. No longer can a penalty be imposed on members who solely serve in an honorary capacity, don’t participate in the day-to-day or financial activities of the organization, and don’t actually know of the failure to collect and relay taxes on time to the IRS.

No good deed goes unpunished. Volunteers who join boards assume potentially dangerous responsibilities, whether they've joined to gain entry to the corridors of power, burnish their resumes, garner opportunities to mix and mingle with the glitterati or just to reciprocate for past favors. They needn’t do due diligence on organizations that do good. But volunteers should assiduously avoid involvement in the collection or payment of withheld taxes, lest they become embroiled in IRS investigations undertaken to ferret out the identities of those worthy of designation as personally liable for unpaid taxes.

About the author:

Julian Block writes and practices law in Larchmont, New York, and was formerly with the IRS as a special agent (criminal investigator) and an attorney. More on this topic is available from “Julian Block’s Year Round Tax Strategies,” available at julianblocktaxexpert.com.

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