Howard v. United States: Who Should Be Responsible for the 100 Percent Penalty?

• Jurisdiction: United States,Federal
• Citation: Vol. 12 No. 03
• Publication year: 1989

UNIVERSITY OF PUGET SOUND LAW REVIEWVolume 12, No. 3SPRING 1989

Howard v. United States: Who Should Be Responsible for the 100 Percent Penalty?

James E. Hungerford

I. Introduction

Every bookkeeper who has check signing authority for a corporation of any size is potentially liable for a penalty of 100 percent of the corporation's unpaid withholding tax liability. A great many bookkeepers are probably not aware of that possibility.

A number of courts have relied upon dicta in Howard v. United States(fn1) to extend liability for the 100 percent penalty of Internal Revenue Code (I.R.C.) section 6672(fn2) to corporate employees who were not even responsible for paying the corporation's withholding taxes.(fn3) The problem with this result is that it penalizes employees responsible for paying other creditors of the corporation, rather than employees responsible for paying the taxes owed by the corporation.

The 100 percent penalty provision of I.R.C. section 6672 imposes a penalty that can far exceed the maximum criminal penalties for fraud or tax evasion. For this reason, the Internal Revenue Service (I.R.S.) should only assess the 100 percent penalty against persons who are clearly liable for the penalty. The maximum criminal penalty for tax fraud or evasion is generally 100,000 dollars,(fn4) whereas liability under the 100 percent penalty provision is unlimited and has been imposed in excess of 989,000 dollars.(fn5) As Justice Rehnquist said in his dissent in United States v. Sotelo, the 100 percent penalty provision "imposes a potentially crushing liability on corporate officials-a liability that is nondischargeable (in bankruptcy) in its entirety and virtually in perpetuity."(fn6)

This Note will discuss section 6672, including its purpose, history, and specific requirements. This Note will then discuss the Howard case and analyze it in terms of the problems associated with section 6672. In conclusion, this Note will suggest solutions to these problems, including a new test for determining who should be responsible for the 100 percent penalty.

II. Section 6672

I.R.C. section 6672, the 100 percent penalty provision, provides in part:(a) Any person required to collect, truthfully account for, and pay over any tax imposed by this title who willfully fails to collect such tax, or truthfully account for and pay over such tax, or willfully attempts in any manner to evade or defeat such tax or the payment thereof, shall, in addition to other penalties provided by law, be liable to a penalty equal to the total amount of the tax evaded, or not collected, or not accounted for and paid over.(fn7)

This penalty is most frequently assessed when federal taxes withheld from employees' wages have not been paid to the I.R.S. by the employer. "Person," as used in section 6672, is defined by section 6671 of the I.R.C. to include "an officer or employee of a corporation, or a member or employee of a partnership, who as such officer, employee, or member is under a duty to perform the act in respect of which the violation occurs."(fn8) Courts have generally held that two separate requirements must be met for a person to be held subject to the 100 percent penalty.(fn9) First, the person must be a "responsible person," that is, the person must be under a duty to collect, truthfully account for, and pay over the taxes.(fn10) Second, the person must have willfully failed "to collect, truthfully account for, and pay over the tax."(fn11)

A. Purpose of Section 6672

The Supreme Court has stated that the purpose of section 6672 is to assure compliance by the employer with its duty to pay such taxes by subjecting the employer's officials responsible for the employer's decisions regarding withholding and payment to a severe penalty.(fn12) The I.R.C. requires employers to withhold social security and income taxes from employees' wages.(fn13) Once these taxes are withheld, the I.R.S. credits the amounts withheld as paid by the employees whether or not the taxes are ever paid to the I.R.S. by the employer.(fn14) The I.R.S. may have to refund some of these taxes to individual employee taxpayers, even though the taxes have never been paid to the I.R.S. by the employer. Although the penalty applies to any tax collected by a third party for the government, most actions under section 6672 are for failure by the employer to pay over employee taxes that have been withheld.(fn15)

The legislative history of section 6672 does not shed a great deal of light on the congressional intent behind the statute, however, the fact that the statute first appeared as part of a criminal statute is significant. That criminal statute was section 1308 of the Revenue Act of 1918, which imposed a 100 percent penalty on any "person who willfully refuses to pay, collect or truly account for and pay over" any excise tax.(fn16) Section 1308 also provided for criminal penalties and the 100 percent penalty could be imposed in addition to the criminal penalties.(fn17)

Subsequent acts made changes in numbering and minor changes in wording.(fn18) The Social Security Act of 1935 incorporated all of the penalties for excise taxes and made them applicable to social security taxes.(fn19) The Current Tax Payment Act of 1943, which provided for withholding of income taxes, incorporated the social security penalties, and thus, by double incorporation, the 100 percent penalty had become applicable to withholding of social security and income taxes.(fn20) Up to this point in the evolution of section 6672, the 100 percent penalty remained a part of the criminal provisions.(fn21)

In 1954, Congress attempted to reorganize the I.R.C. to provide a more logical arrangement.(fn22) In this rearrangement, Congress severed the 100 percent penalty from the other criminal provisions because it did not provide for imprisonment.(fn23) It was at this time that the 100 percent penalty was numbered as section 6672 and placed in the code along with other sections imposing civil penalties.

Although the legislative history of section 6672 says little about the congressional intent with regard to its interpretation, it is at least clear from the history of the statute that it was originally intended as a criminal sanction.(fn24) In this regard, the construction of specific terms within the statute such as "willfully" should be similar to the construction of such terms in other criminal statutes.(fn25) As will be discussed below, this has not always been the way such terms have been construed by the courts. In fact, most courts that have addressed the purpose behind section 6672 have assumed that the purpose is as stated in the Internal Revenue Manual: To encourage prompt payment of withheld and other collected taxes as provided by law, and to insure ultimate collection of such taxes from a secondary source in any event, Congress enacted IRC 66T2.(fn26) The original nature of section 6672 as a criminal sanction has been lost, and the courts have instead described the statute as an alternate collection device.(fn27) As stated in Newsome v. United States: "[sjection 6672's Tjasic purpose is the protection of government revenue."(fn28) However, in light of the original nature of section 6672 as a criminal sanction, the Supreme Court was more accurate in its statement that the purpose of section 6672 is to assure that the duty to pay taxes is fulfilled.(fn29)

B. The Requirements for Section 6672 Liability

1. "Responsible Person"

The first requirement for liability under section 6672 is that the taxpayer must be a "responsible person." A responsible person,(fn30) as defined by section 6671, includes an officer or an employee of a corporation, among other persons.(fn31) The use of the term "includes" in section 6671 has generally been found to be significant in that the persons listed under the statute are not construed to exclude all others.(fn32) On the other hand, holding a corporate office does not necessarily make the officeholder a responsible person.(fn33) The overwhelming weight of authority indicates that a responsible person must have the power to control the decision-making process by which funds are allocated to other creditors in preference to paying taxes that are due.(fn34)

The courts generally look to factors like check signing authority, day-to-day management of the company, and control of voting stock as indicators of who has the power to control the allocation of funds.(fn35) For example, in Godfrey v. United States, the Federal Circuit Court found that a chairman of the board of directors did not have the power to control the allocation of funds because he was an outside director with no significant voting stock, no check signing authority, and no involvement in the day-to-day management of the corporation.(fn36) He was therefore not liable for the 100 percent penalty.(fn37)

2. "Willfulness"

The second requirement for liability under section 6672 is that the responsible person acted "willfully." The test for willfulness was established by the Ninth Circuit Court of Appeals in Bloom v. United States.(fn38) For a person to be found to have acted willfully within the meaning of the statute, that person must have performed a "voluntary, conscious and intentional act to prefer other creditors . . . over the United States."(fn39) In Bloom, the court found that payments on a bank loan and payments of net wages to employees made while taxes were owing...