In Whom We Trust

• Publication year: 2022

43 Creighton L. Rev. 357. IN WHOM WE TRUST

IN WHOM WE TRUST

T. KEITH FOGG(fn*)

ABSTRACT

The Internal Revenue Service ("IRS") collects the majority of taxes through business entities that are required to withhold taxes from wages or collect excise taxes at the time of providing services. These business entities hold the taxes they collect in trust for the IRS. The vast majority of business entities pay over the taxes held in trust in a timely and appropriate manner; however, a sizeable amount, in dollar terms, does not get paid. Aside from passing criminal laws at or near the passage of the 1954 code, Congress has done little to create a structure that provides incentives for business entities acting as trustees to pay over these collected taxes.

This Article explores the literature that has primarily developed with respect to the tax gap seeking to find structural answers to the problem. Most of the literature addresses issues concerned with underreporting taxes rather than the underpayment of taxes but certain ideas on how to influence taxpayer behavior are transferable to underpayment. Applying appropriate structural principles to the problem, the Article explores some of the solutions adopted by states to see if importing those solutions could assist the federal government in collecting these taxes.

Five specific recommendations follow from the study and these recommendations range from information gathering to monetary incentives for timely compliance to requiring bonds. The range of proposed solutions is intended to address the range of reasons for the non-compliance. Through the implementation of these solutions or similar ideas that create the proper structure for taxpayers serving as trustees, this corner of the tax gap should be reduced.

TABLE OF CONTENTS

I. INTRODUCTION ................................... 358

II. TRUST PROVISIONS............................... 362

III. PROPER COMPLIANCE INCENTIVES............. 364

IV. PAST AND CURRENT COMPLIANCE EFFORTS ... 369

V. PROPOSAL FOR CHANGING THE SYSTEM OF

ADMINISTRATING RECOVERY OF COLLECTED

TAXES............................................. 374

A. SELF IDENTFICATION OF RESPONSIBLE OFFICER ... 374

B. INCENTIVES FOR SMALL BUSINESSES TO TIMELY

PAY COLLECTED TAXES........................... 386

C. REQUIRE BONDS OF INDIVIDUALS OR ENTITIES

WITH HISTORY OF FAILTURE TO PAY COLLECTED

TAXES........................................... 391

D. ELIMINATED THE WITHHOLDING AND SOCIAL

SECURITY CREDIT FOR RESPONSIBLE OFFICERS

WHO FAIL TO PAY ENTITY'S EMPLOYMENT

TAXES........................................... 398

E. CREATE AN INCENTIVE FOR THE RESPONSIBLE

OFFICERS TO PAY THE INTERNAL REVENUE CODE

SECTION 6672 LIABILITY WHEN MORE THAN

ONE RESPONSIBLE OFFICER EXISTS ...............402

VI. CONCLUSION .....................................405

VII. APPENDIX a.......................................407

VIII. APPENDIX B.......................................418

I. INTRODUCTION

Congress chose to use business entities as the primary tax collectors in the United States.(fn1) Employers collect federal income taxes and social security taxes from their employees. Telephone, airline, and oil companies collect federal excise taxes from their customers. As they collect these taxes, the business entities become trustees for the United States for the money they hold.(fn2) Most business entities acting as trustees timely pay over the amounts they have collected; however, some business entities fail to remit the monies they hold in trust. Currently, the tax gap for unpaid "collected taxes"(fn3) exceeds $58 billion.(fn4) This Article proposes some actions that can address that segment of the tax gap with a goal of creating a structural system that leads businesses collecting taxes for the Internal Revenue Service ("IRS") toward better compliance while reducing the requirement for collection action by the IRS.

While almost every business entity has the prospect of becoming a trustee for the IRS, the IRS does not know much about its trustees and the individuals who manage these business entities. As with income taxes, it relies on a system of self reporting by the business entities that owe the tax. The IRS only becomes engaged when it perceives a problem, which is often much too late to effectively recover the unpaid tax.

The process of allowing anyone to serve as a trustee for collected taxes leads to having many unqualified trustees. The entities serving as trustees and their corporate officers are often unaware that the collected taxes constitute a trust that the entity holds for the benefit of the IRS. The entities become trustees almost from the moment of formation, meaning that this obligation lands on them at their most financially vulnerable time. As these entities and the officers responsible for these entities do not understand that the funds collected from others for the payment of their taxes constitute a trust, and because the IRS does not know who the trustees and their responsible officers are in many instances, too much of the money ostensibly held in trust in this manner simply does not get paid.

This Article is the second addressing problems with the collection of taxes held in trust. The first article addressed a problem with the manner of charging interest under Internal Revenue Code ("IRC") section 6672(fn5) and it proposed a statutory change to fix the problem by requiring the persons liable under section 6672 to pay interest back to the due date of the return reporting the collected taxes.(fn6) This Article addresses structural problems in the system of collection from the parties responsible for the taxes held in trust.(fn7) It contains recommendations that span both administrative and statutory problems. By providing better information to the corporate officers about their duties as trustees, obtaining better information from these individuals concerning who is responsible and revealing certain other structural incentives, this Article proposes a framework for reducing the shortfall in payment of the taxes collected for the United States but never paid over. As discussed further below, it is by providing the appropriate structural framework that the government can most effectively ensure the payment of taxes.(fn8)

Five specific proposals receive attention in this Article. These proposals seek both to inform and cajole the individuals running the trust to timely perform their duties by: (1) requiring disclosure of all responsible officers of an entity at the time the entity forms and seeks an employer identification number ("EIN") and providing those individuals with a detailed list of their duties in running the trust on behalf of the IRS as well as a detailed list of the consequences of failure; (2) providing financial incentives for timely compliance to small businesses; (3) requiring bonds of entities that fail to comply or which have as responsible officers individuals who have failed to comply in the past; (4) eliminating the crediting of withholding and social security taxes for individuals who are responsible for an entity failing to pay over the taxes to the United States in a timely manner; and (5) in cases in which an entity has multiple responsible officers liable for failure to pay the trust fund monies, providing an incentive to the responsible officers to be the first ones to pay.

Non-compliance with payment of collected taxes generally occurs with small businesses and not with large ones.(fn9) While large businesses tend to get much of the press, small businesses make up the vast majority of firms in the United States.(fn10) Over half of the United States labor force works at small businesses.(fn11) The failure rate of these businesses is high; thirty percent of small businesses close within two years of opening and fifty percent close within four years.(fn12)With these rates of failure, the importance of having small businesses keep current on their tax obligations is critical. In the start up years these businesses typically owe very little, if anything, in income taxes. The federal tax obligation that impacts them most is the employment tax liability, much of this liability is money these businesses collected from their employees and hold in trust for the United States.(fn13)

Before detailing the specific proposals, the Article will create some context for the proposals by discussing applicable trust law principles. These principles should guide the thinking on how to structure a trust relationship between the IRS and those the IRS designates as its trustees. Another preliminary matter to be discussed, as well as one that will flavor specific proposals is the significant body of research on what makes an effective tax law, one that provides the proper incentives for compliance as well as the proper remedies for non-compliance. Almost no structural changes to the trust fund provisions of the IRC occurred since enactment. The wealth of research that has taken place over the years should serve to inform proposals for changing its structure. As a preliminary matter, this Article also looks at the meager prior efforts to change the structure of this system to determine how those efforts have worked to date.

II. TRUST PROVISIONS

In general terms, a trust is a mechanism for creating a fiduciary relationship with respect to property. A trust...