Tax & Business Insights

Trust Fund Disclosure - Part I

Volume 16 Issue 3 --  May/June 2004

This issue is part of a two-part discussion.  For a longer version of this two-part discussion, CLICK HERE.

Disclosure in this context does not relate to what kind of underwear you wear, but what involvement a taxpayer may have had with regard to an entity that did not pay its proper share of withholding and Social Security taxes.  The disclosure that we are concerned with is an important, sometimes crucial, part of handling a Trust Fund Penalty case.

All employers are required to collect and remit to the IRS their employees’ withholding and the employees’ one-half of Social Security payments. The amounts shown on the pay stubs as subtractions from the gross pay of the employee are to be collected and remitted by the employer.  This amount is called “the Trust Fund portion, because these funds are legally the employees’ money, not the employer’s.  The Government considers the failure to collect and pay these Trust Fund amounts to be a breach of the responsibility of the business and its related parties.

Employers sometimes run short of money, such as when they are waiting for an overdue payment from a customer. It is seemingly easy and tempting to “borrow” from the Government by not paying the Trust Fund amounts.  Unfortunately, borrowing this way comes with Draconian penalties, not only for the employer but often for individuals who run the employer, whenever the employer fails to pay the Trust Fund portion to the Government. 

Section 6672 Trust Fund Penalty

Often, businesses that take these sorts of chances with Trust Fund taxes end up “folding.”  When they do, there is the onerous Internal Revenue Code § 6672 which creates the Trust Fund Penalty.  This penalty used to be called the 100% Penalty which was a misnomer, because it never was 100% of the employer’s liability. The Trust Fund Penalty does not include the employer's portion of Social Security taxes.

When an employer has failed to pay its Trust Fund amounts, any “responsible party” associated with the employer may be held personally liable for the Trust Fund amounts not paid by the employer. Internal Revenue Code § 6672 provides that, if the Trust Fund portion of the 941 withholding taxes is not remitted to the IRS, the IRS is able to convert the employer’s corporate liability into a personal liability of those deemed to be “responsible parties.”

One great difficulty is applying the so-called Responsible Party Test to the myriad factual situations that develop.  Moreover, there is always the “It wasn’t my responsibility” syndrome.  

In the simplest of cases, where there is one corporation and one shareholder who signed the payroll checks, identifying the responsible party is quite easy.  The task becomes more difficult when the case involves a larger corporation or entity with two or three, or more, potentially responsible parties. 

Often, the IRS will assert that all of the top officers and sometimes the bookkeeper are responsible parties.  The Trust Fund Penalty can also be imposed against bank officers, accountants, lawyers, and others who take over a business and pay “net payroll,” the amount which the employees would get under normal pay circumstances.

Let’s assume that a corporation, MBrok, Inc., has a president, Mr. Top, while Mr. Notme, and Ms. Evasif (hereafter, “Top,” “Notme,” and “Evasif”) are other key officers.  Before it finally failed, MBrok had cash-flow problems and began not remitting the Trust Fund taxes to the IRS.  If the IRS suspects that any of these three individuals had anything to do with the decision to not remit the funds to the IRS and instead to pay other creditors, the IRS will likely contact and seek to question all three of these individuals. 

Collecting Information

The mechanism for collecting this information usually consists of a Revenue Officer talking with a target and completing a Form 4180, Report of Interview with Individual Relative to Trust Fund Recovery Penalty” (hereafter “Disclosure Statement”).   The purpose of the five-page form is to collect substantial amounts of data from those suspected of being responsible parties.  Typically, the Revenue Officer will fill out the Form 4180 and ask the potential target to review it.  If your client is a potential target in a Trust Fund Penalty case, it is vitally important that he or she receive assistance before the IRS Revenue Officer comes to obtain the Form 4180. 

Often, potential Trust Fund Penalty targets have no legal representation when they are interviewed by the IRS and the Revenue Officer will be free to question Top, Notme and Evasif separately.  Some of the questions are difficult to answer.  Often, an individual like Notme will not understand the significance of some of the questions. 

In the next issue, we will discuss why representation at an early stage is so important and what steps should be taken in representing clients who face the Trust Fund Penalty. 

This issue is part of a two-part discussion.  For a longer version of this two-part discussion, CLICK HERE.


Copyright 2004
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