"Reasonable cause" defense to imposition of 100% withholding tax penalty against responsible persons.

• Author: Goldberg, Michael

The Tenth Circuit ruled in Finley, 10th Cir., 8/20/97, when a business has failed to remit Social Security and income taxes (so-called trust fund taxes) withheld from employees' wages, "responsible persons" can avoid the 100% penalty by showing the existence of "reasonable cause. " Finley involved Johnson, corporate president, and Finley, secretary-treasurer, of Halsey-Tevis, Inc. Their corporation was in financial difficulty. In October 1988, Finley advised Johnson that the corporation was delinquent in paying trust fund taxes. Johnson replied that "[t]hey have to be paid" and Finley responded that partial payments were being made. In fact, Finley had used his knowledge of the corporation's accounting records to hide the delinquency.

Johnson took no further action and made no further inquiry with respect to the unpaid taxes, and it was not until two weeks later that Johnson learned that Finley still had not paid the delinquent taxes. That same day, the corporation's bank froze the bank accounts; at that point, no bills could be paid without the bank's approval. One week later, Johnson and Finley delivered funds to the bank, requesting that they be applied to the delinquent taxes. The bank refused and instead applied the funds to the corporation's outstanding bank loans, with bank officials telling them that they would take care of the taxes later.

Sec. 6672 provides that, if a person responsible for collecting and paying over trust fund taxes willfully fails to do so, such person is personally liable for a penalty equal to the unpaid tax. (Most, if not all, states have similar provisions with respect to state trust fund taxes.) The wording of Sec. 6672 seems to allow the IRS to collect the full penalty from each responsible party, although the Service's policy is to collect the penalty only once. The IRS continued to seek the penalty from Johnson after winning a judgment against Finley (due to Finley's apparent inability to pay). There was no indication that the IRS sought to assess the penalty against the bank, although Sec. 6672 does not preclude such action.

At Johnson's trial, the jury found that he, admittedly a responsible person under Sec. 6672, had shown by a preponderance of the evidence that he did not willfully fail to pay the trust fund taxes. The trial judge, however, set aside the jury verdict and ruled that Johnson was liable; he held, as a matter of law, that a reasonable jury could not have found that Johnson met his...