Recently, I started advising three entrepreneurial brothers who are the controlling shareholders of three companies with several hundred employees. All of their businesses are presently short of operating cash and unable to borrow from banks or other conventional sources. Without quick infusions of funds, they’ll likely go under.
They won’t be able to pay skittish suppliers who refuse to extend additional credit, even if the brothers guarantee payment. Nor will they be able to pay employees. Many of these workers have high salaries and possess skills that are hard to replace in a tight job market. The ones who jump ship will readily find work with competing companies.
While my future clients were foraging for funds, they encountered a person I’ll call Curly, someone who recently ended a stint as a low-level White House staffer. Curly continually touted his tax expertise and ties to politicians.
The brothers were so awed by their new acquaintance that they gave him a high, five-figure payment for a strategy that he’d imparted to lots of other cash-strapped businesses: Have their companies pay employees their net salaries but not remit hefty amounts of withheld income taxes and Social Security taxes to the IRS. Instead, use that money to satisfy suppliers. After all, as Curly assured the brothers, just as soon as business inevitably picks up, the companies can repay what they had “borrowed” from the IRS.
First, though, my new clients sought my blessing. I demurred. All I had to do was rattle off long-standing rules set forth in Internal Revenue Code Section 6672. These empower and encourage the IRS to act firmly and swiftly against companies that withhold taxes from paychecks but fail to pass them along in a timely manner.
Like lots of other business owners who are unaware of Code Section 6672, my clients may think they’re doing nothing dishonest when they dip into the withholding kitty to make up temporary cash shortfalls. But many thousands of individuals who’ve played games with withheld taxes have been stunned to discover that their 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 belatedly learned that the IRS routinely assesses penalties equal to 100 percent of the amounts due against the people who are responsible for collecting or paying withheld taxes and who “willfully” fail to collect or pay them.
That portion of my homily prompted the brothers to ask whether they’d be considered responsible persons. I told them that there can be no two opinions about whether they would be. After all, who else would decide which creditors to pay and when?
Worse yet, they’d also be jointly liable for the entire amounts owed. This would hold true even if, despite their controlling interests, they were somehow able to establish that other persons were more responsible than they were for the collection, accounting and payment of the missing taxes.
How does the IRS define “responsibility”? Let me count the ways. 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
Generally, the agency pursues 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 on behalf of the business entity." Employees in this grouping include secretaries, clerks and bookkeepers.
How does the IRS define “willfulness”? It only requires a conscious, voluntary act, not intent to defraud. The act doesn’t have to be one of commission. It can be one of omission, as when a person fails to investigate or correct mismanagement. Many clients ask ask: What if you file for personal bankruptcy? That does not relieve you of responsibility for your company’s failure.
The IRS does cut some slack for volunteers. The law authorizes relief for people who serve as unpaid members of boards of schools, museums and other tax-exempt groups. The agency doesn’t impose penalties 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.
Volunteers who join boards assume potentially dangerous responsibilities, whether what entices them to sign on are enhanced entries to the corridors of power, burnishing their resumes, opportunities to mix and mingle with the glitterati or just to reciprocate for past favors. While volunteers needn’t perform due diligence on organizations that do good, they 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.
Additional articles. A reminder for accountants who would welcome advice on how to alert clients to tactics that trim taxes for this year and even give a head start for next year: Delve into the archive of my articles (more than 275 and counting).
About Julian Block
Attorney and author Julian Block is frequently quoted in the New York Times, Wall Street Journal, and the Washington Post. He has been cited as “a leading tax professional” (New York Times), an “accomplished writer on taxes” (Wall Street Journal), and “an authority on tax planning” (Financial Planning magazine). More information about his books can be found at julianblocktaxexpert.com.