Financial woes as reasonable cause for payroll tax nonpayment.

• Author: Tapajna, Joseph J.
• Position: Procedure & Administration

Can financial woes excuse taxpayers from depositing or paying payroll taxes? The Ninth Circuit has now joined two other circuits in saying "yes." In Van Camp & Bennion, 6/6/01, the IRS assessed depositary and late-payment penalties against a law firm for failing to remit employment taxes over a three-year period. The taxpayer paid the penalties, then sued for a refund. It argued, among other things, that the ill health of the partner largely responsible for generating the firm's revenue excused it from paying. The district court disagreed, citing Brewery, Inc., 33 F3d 589 (6th Cir. 1994). In Brewery, the Sixth Circuit held that, as a matter of law, financial distress never constitutes "reasonable cause" for failing to pay withholding taxes. The court reasoned that, under Sec. 7501(a), such taxes are held in trust for the government; thus, an employer may never use them to pay other expenses. Put simply, the government may not be made "an unwilling partner" in a taxpayer's business.

On appeal, the Ninth Circuit reversed and remanded, rejecting Brewery's logic in favor of the Second Circuit's in Fran Corp., 164 F3d 814 (1998), and the Third Circuit's in East Wind Industries, Inc., 196 F3d 499 (1999).

Fran Corp.

In Fran Corp., an electrical contractor failed to pay nearly $150,000 of withheld and other payroll taxes over five quarters. The government conceded that during this period, the taxpayer experienced severe financial difficulties stemming from two projects it was forced to complete despite payment defaults by the contracting parties. The Second Circuit rejected the government's invitation to follow Brewery, observing that nothing in the tax laws rules out reasonable cause for not paying payroll taxes. The court noted that, under Regs. Sec. 301.6651-(c)(1), taxpayers have a reasonable cause for paying taxes late if they exercised ordinary business care and prudence to pay them on time, but were unable to do so because of undue hardship. Under the regulation, all the facts and circumstances of the taxpayer's financial situation must be considered to assess reasonable cause. The court found nothing to support a different rule for payroll taxes. Nonetheless, it found that the taxpayer failed to establish reasonable cause (i.e., that it exercised ordinary business care and prudence). The court noted, among other things, the taxpayer continued to pay rent to its president, but failed to call a large loan it had made to him. In addition, the...