When the Irs Wants Your Client to Pay Trust Fund Taxes-part I

• Publication year: 1997
• Pages: 117

26 Colo.Law. 117 Colorado Lawyer 1997.

1997, September, Pg. 117. When the IRS Wants Your Client to Pay Trust Fund Taxes-Part I

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117

Vol. 26, No. 9, Pg. 117

The Colorado Lawyer
September 1997
Vol. 26, No. 9 [Page 117]

Specialty Law Columns
Tax Tips
When the IRS Wants Your Client to Pay Trust Fund Taxes--Part I
by Jerome Borison, Steven R. Anderson
C 1997 Jerome Borison and Steven R. Anderson

You get a frantic call one day from a client. She says "Remember that corporation I was vice-president of until about six months ago? Wen, I just received a letter from the IRS stating that I owe $125,000 for unpaid employment taxes That isn't possible is it? I don't have that kind of money--it will wipe me out. Besides, you told me that as a shareholder of a corporation, I had limited liability What's going on?"

Sadly, this scenario arises all too often. Failing businesses, confronted with creditors who have refused further extensions of credit, often "borrow" the funds withheld from employees1 that are due to be paid over to the IRS.2 Naively, many owners assume the business will turn around and they will meet their IRS obligations. The diversion of funds "pyramids" one quarter on top of the other and, in many cases, forces the business to file bankruptcy or to shut down. Worst of all, the IRS is still owed taxes and, employing § 6672 of the Internal Revenue Code ("Code"),3 can demand payment from those it believes are responsible for the default.

This article attempts to familiarize the practitioner with the law, procedures, and strategies associated with representing someone against whom the IRS is asserting the Code § 6672 penalty. This Part I looks at the law and available defenses associated with the words "responsible person" and "willful." Part II, to be published in the October issue, will examine the procedures surrounding the § 6672 penalty. Part III, to be published in the November issue, will discuss information gathering from a client and others and strategies the attorney should consider using in Code § 6672 cases.

Background

Section 6672 is probably the most IRS-invoked section of the Code. The statute creates a unique vehicle for the collection of "trust fund" taxes--those taxes collected from employees and "...held to be a special fund in trust for the United States."4 In the context of employment taxes, the term "trust fund taxes" refers only to taxes withheld from employees-federal income tax and one-half of FICA--and not to employment taxes that the business itself owes, such as its share of FICA or FUTA (unemployment tax).5

Regardless whether the IRS also is proceeding against the business as the primary obligor, Code § 6672 empowers the IRS to collect the unpaid trust fund tax liabilities of corporations and other types of limited liability entities from the personal assets of those persons who were responsible for the nonpayment of the taxes. In effect, the statute enables the IRS to "pierce the veil of limited liability" and held many individuals secondarily or vicariously liable.

For any particular trust fund deficiency, several persons may be held jointly and severally liable. Because more than one person can be found liable and in order to enlarge the pool of personal assets from which the underlying tax may be collected, the IRS often asserts the penalty against everyone who might be liable under the statute. Their motto is: "When in doubt, assert the penalty and let them fight it out among themselves." Thus, it is not unlikely the attorney may be defending someone who, in the attorney's opinion, should never have been targeted in the first place.

Ultimately, however, in order for an individual to be liable under Code § 6672, it must be determined that (1) the individual was a responsible person (someone who has the status, duty, and authority over the financial decision-making), and (2) the individual willfully failed to collect, truthfully account for, and pay over trust fund taxes (by knowingly paying other creditors while the trust fund taxes were due the IRS). The absence of either element vitiates liability. In other words, the individual can escape liability by proving that either of the two elements6 is not satisfied. The burden of proof is on the taxpayer.

The "Responsible Person" Element

Only those persons who are responsible for the nonpayment of taxes have to worry about Code § 6672. A "person" is defined in §§ 66717 and 7701(a)(1)8 and the statement of when liability attaches is in §6672(a).9 Interestingly, however, the Code does not define who is a "responsible person," leaving that definition to be filled by case law. "A responsible person may be an officer or employee of a corporation, a part-her or employee of a partnership, a corporate director or shareholder, another corporation, an employee of a sole proprietorship, a surety lender, or any other person or entity outside the delinquent business organization."10

The determination of whether an individual is a responsible person is a factual question,11 A person's title is not controlling. The touchstones for determining whether an individual is a responsible person are the person's "status, duty and authority" within the organization.12

Most commonly, responsibility attaches when a person has the authority to decide which creditors to pay and when such action should occur. In other words, a person is responsible if he or she has the ability to control the purse strings of the business13 It is not necessary that the Individual have the final word.14 When one has the requisite authority to make payment to the IRS, yet fails to assert it when directed otherwise, he or she can be held liable under § 6672.15

Lack of knowledge is not a defense to the responsible...