Tax Court: Avoiding the Dreaded Trust Fund Penaltyby
If payroll taxes aren’t remitted to the IRS in time, a responsible party may be held personally liable for the full amount of the unpaid tax; essentially, you’ll have to pay the IRS out of your own pocket. This harsh “trust fund penalty” is frequently contested in the courts.
In a new case, Hartman, DC-MI, 7/26/17, the IRS imposed the penalty on a co-owner who wasn’t even the one handling the payroll duties. Briefly stated, the trust fund penalty may be applied to anyone who is responsible for collecting or paying payroll taxes and willfully fails to do so.
The IRS takes a broad view of who is included in the definition of a responsible party and what constitutes a “willful failure.” For instance, the penalty may be assessed against an owner who knew or should have known about the unpaid tax.
The taxpayer in the new case owned 50% of a tool and design company and served as the CEO. The other 50% owner acted as the COO until the taxpayer laid him off. Both owners had the authority to access the company’s money and sign checks for it.
Usually, the taxpayer signed employees' paychecks, while the COO prepared the payroll tax deposits. Until December 2003, the company used a third-party payroll service provider to process its paychecks.
But the payroll service provider backed out after the company experienced financial difficulties. Although the taxpayer knew that his company would not pay its payroll taxes on time in December 2003, he anticipated that they could address the shortfall early in 2004. At this time, the company was using an in-house software system for handling payroll matters, based on the COO’s recommendation.
The taxpayer maintained that COO was the only person entrusted with paying the company’s payroll taxes. He claimed that he did not learn that payroll taxes weren’t being paid until July 2004 when he went through the COO’s desk. This precipitated a meeting with IRS to discuss the shortfall.
Despite efforts to shore up its liabilities, the company continued to miss deadlines for remitting taxes. At another meeting with the IRS, the taxpayer protested that the in-house accounting software indicated that the payroll tax checks were being cut.
Eventually, the taxpayer fired the COO for performance issues, yet he continued to rely on him to pay the payroll taxes! Based on these facts, the district court determined that the taxpayer was both responsible and had willfully failed to pay the payroll taxes.
He had complete authority to make the deposits with the IRS. In addition, he exhibited reckless disregard relating to the tax liability.
Even when he became aware of the failure, he didn’t do anything about it. In fact, he continued to rely on the COO for paying the payroll taxes. Thus, the court ruled that the taxpayer is personally liable.
Your clients should ensure that payroll taxes are being paid on time through a system of checks and balances. Optimally, the person assigned this responsibility should have back-up support and be subject to oversight. If you’re involved in the procedures, take the steps necessary for protection against the trust fund penalty.
Ken Berry, Esq., is a nationally known writer and editor specializing in tax, financial, and legal matters. During his long career, he has served as managing editor of a publisher of content-based marketing tools and vice president of an online continuing education company. As a freelance writer, Ken has authored thousands of articles for a...