Prepared August, 2004
Disclosure in this context does not relate to what kind of underwear you wear, but what involvement you may have had with regard to an entity which did not pay its 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.
When a business fails to collect and remit the employees'
withholding and the employees' one half of Social Security – the so-called
Trust Fund portion, the Government considers this to be a breach of the
responsibility of the business and related parties. Stated differently, the
amounts shown on the pay stubs as subtractions from the gross pay of the
employee are to be collected by the employer and remitted to the Government.
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 to
the Government. Unfortunately, borrowing this way comes with
Draconian penalties, not only for the employer but often also for those
individuals who run the employer, whenever the employer fails to pay the Trust
Fund portion to the Government.
Often, these businesses that take these sorts of chances with Trust Fund taxes
end up "folding." When they do, there is the onerous IRS Code Section
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 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 situation involves a larger corporation or entity with two or three, or more, possible 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.” In this context, net payroll means the amount which the employees would get under normal pay circumstances, whereas the amounts that are deducted on the pay stub but not remitted to the Government comprise the Trust Fund portion.
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.
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.
As an illustration, one of the questions on Form 4180 is, “During the time the delinquent taxes were increasing, or at any time thereafter, were any financial obligations of the corporation paid"? If the answer is “yes,” and Notme knows who was paid, then the IRS might argue that Notme knew what was going on and thus is a responsible party. The IRS will assume that Notme knew that delinquent taxes were increasing but paid other creditors, or that Notme participated in the decision to pay other creditors.
The gravamen of the Trust Fund Penalty is that a creditor other than the United States was preferred over (or paid before) the United States. It goes back to the old adage that the "King's debtor is dying; the King shall be first paid." In modern times, that means if a corporation failed to pay its taxes, then the individuals who caused any one other than the IRS (the King) to be paid are now the responsible parties.
It is quite unusual for an individual to have representation at the information-gathering stage but representation at that time can be crucial. The Disclosure Statement is designed to trap anyone peripherally involved with a corporation like MBrok, Inc. into admitting facts that could give the IRS grounds for treating him or her as a responsible party.
Inevitably, there is finger pointing between Top, Notme, and Evasif. It behooves everyone to blame the failure to withhold on another party. In some cases, where there really is no substantial involvement in the employer's payment decisions, the representations on the Disclosure Statement can be very important.
Let's say that Notme was really only peripherally involved and did not have the authority to make the decisions necessary to cause the Trust Fund Penalty to be imposed against him. If Notme has a legal representative at the meeting with the Revenue Officer and who has had a chance to review the Disclosure Statement before the questions begin, then Notme might have a chance of avoiding the Trust Fund Penalty. In such situations, the right to Counsel and advice concerning how to respond to the questions on the Disclosure Form can be extremely important.
The reality is that the IRS will often pursue nearly anyone who had any possible authority to make the decision about which creditors get paid, thus potentially causing the IRS not to be paid. By IRS standards, the more people who are proposed targets for the Trust Fund Penalty, the more likely it is that there will be discussions among them about who is truly responsible. Since the IRS usually arrives last and has the most authority, the tableau is a grim one.
If Notme is a proposed target of a Trust Fund Penalty, he will receive an IRS Form 2751, notifying Notme that the penalty is being considered. Notme will have 60 days to appeal in writing the proposed Penalty to an IRS Appeals Officer. During this period of time, no interest is imposed against the target, Notme.
If you are representing a taxpayer in this situation, one of the first things you should do is ask for a copy of the Disclosure Statement, Form 4180. Many times, a practitioner will work hard trying to get a person absolved from the Trust Fund penalty only to find out later that there are damaging statements on a Form 4180 which make avoiding the Trust Fund Penalty more difficult or impossible. If you, as the representative, do not get a copy of the form and review it prior to preparing an Offer in Compromise or contesting the proposed Trust Fund Penalty, you might be sorely disappointed when you eventually meet with an appeals officer concerning the matter.
There are quite a few court decisions supporting the principle that the Trust Fund Penalty should not automatically be imposed against the top officers of a corporation based on the mere fact that an individual is an officer. In many instances where the president is titular and does not participate in financial decisions, it is possible for such a president, like Top, not to be held responsible for the Trust Fund Penalty. Again, the statements made to the Revenue Officer on the Disclosure Statement can be quite important.
In some large-sized, and even medium-sized, corporations, the choice of payment of creditors is left entirely to a subordinate. The IRS will often argue that since the president could fire the subordinate, the president had the ultimate control. Such an argument is often compelling with IRS appeals officers, it seems, but does not absolutely mean that the top officers are always responsible for the Trust Fund Penalty.
The attitude of most IRS Appeals Officers is if someone had "colorable authority," then they were responsible for the Trust Fund Penalty. This is an extremely difficult area of law. Also, it is often hard to get the parties against whom the Trust Fund Penalty has been assessed to agree to some sort of proportionate payment of the Trust Fund Penalty.
It is little wonder that many practitioners do not want to represent individuals who are subject to the Trust Fund Penalty. However, in circumstances where Notme or Evasif, or even a president of a company, Top, are involved, effective representation can make a difference.
If the Trust Fund Penalty has been asserted against your client and you have not had success in appealing the assessment, there are still courses of action that can be considered by the taxpayer. Without getting into an elaborate definition of these alternatives, these include:
(1) To pay the Trust Fund Penalty for one employee for one quarter and then file a Claim For Refund. After six months, if the Claim is not granted, then there is jurisdiction to file a refund suit in Federal District Court. In a refund suit, the taxpayer's status as a "responsible party" can be litigated.
(2) To submit an Offer in Compromise based on doubt as to collectibility. While this does not defeat the Trust Fund Penalty, it does provide a mechanism to make the payment of the penalty more manageable.
(3) To request an Installment Payment Agreement. An Installment Payment Agreement does not reduce the total amount due or the interest, but allows the person against whom the penalty has been imposed to pay the same over a period of time in installments.
This is an extremely difficult area of law where effective tax representation can be quite important for those on the periphery. If the individual being investigated for the Trust Fund Penalty signed the checks and made the decisions, it is often a slam-dunk case. However, many times, lower-level officials, or higher level officials who did not participate in the decision, can be relieved of the Trust Fund Penalty.
If you have questions about these types of matters, call the Tax and Business Professionals at 800-553-6613.
Copyright 2004
By Tax and Business Professionals, Inc.
9837 Business Way
Manassas, VA 20110
(800) 553-6613
While designed to be accurate, this publication is not intended to constitute the rendering of legal, accounting, or other professional services or to serve as a substitute for such services.
Redistribution or other commercial use of the material contained in Tax & Business Insights is expressly prohibited without the written permission of Tax and Business Professionals, Inc.
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