Payroll Tax--Trust Fund Penalty
General Information on the Trust Fund Penalty
The trust fund recovery penalty allows the IRS to collect the unpaid withholding taxes from the assets of the owners and operators of businesses. It penalizes those who had control over the decision to divert the payroll money from the IRS to other creditors of the business. The trust fund recovery penalty is equal to the income taxes, social security taxes, and Medicare taxes withheld from employee paychecks. The trust fund recovery penalty is authorized by Sec. 6672 of the Internal Revenue Code (IRC).
There is also a non-trust fund component to employee payroll withholdings. Non-trust fund taxes equal the employer's required matching to the employees' social security and medicare fund. These contributions are made from the employer's own pocket rather than deducted from employee paychecks. There is no personal liability for non-trust fund withholdings; they can only be collected from the business.
Trust fund penalties are those penalties that generally arise when a business fails to file or pay some manner of tax (sales tax, FICA, unemployment, etc.) that was withheld by the business from a customer or employee. These penalties are one of the most onerous penalties in the tax code, as they are nondischargeable in bankruptcy. Further, they are one of the few liabilities that statutorily pierce the corporate/LLC veil as to owners and operators of businesses. Even more concerning, they can extend to accountants or management members who unwittingly subject themselves to said liability by simple ministerial acts, such as handling payroll or writing checks. Trust fund penalties are subject to interest accruals which almost always prove financially devastating, as they frequently are assessed years after the tax was payable.
The IRS can choose to assign penalties to one or more people, selecting whom to collect from without any concern for fairness in the collection process. For instance, even if multiple parties are deemed to owe the business taxes but one individual has greater resources than the others do, the IRS can, and usually will, pursue collection against the wealthier person, taking the path of least resistance in accomplishing their collection objectives.
For these reasons, among others, in trust fund liability cases, it is imperative to assess the possibility of contesting the penalty or limiting its assessment before it is assessed. This analysis begins with a core understanding of what the Service must prove to assert the penalty, when to contest the liability and understanding the IRS's use of Form 4180 to seal the deal on assessments to individuals or conversely for tax advocates to defend against the assessment of such liability. Such an analysis, performed as early as possible for the client, is imperative, as the IRS utilizes the nondischargeability of trust fund penalties in bankruptcy as a basis for bolder collection efforts.
Moreover, trust fund liabilities carry the significant stigma of a tax that a person elected to take from another person and chose not to pay to the government but rather to other creditors. This fact is dubious for future tax resolution as it makes the individual taxpayers assessed with the penalty less likely to be awarded equitable tax relief even if they can demonstrate true inability to pay the tax. In equitable relief programs, such as offers in compromise or penalty abatements, trust fund penalty cases are generally viewed in the dimmest of light.
The most common trust fund penalties we deal with emanate from payroll withholding tax and the assessment of the trust fund portion of said tax to "responsible persons" pursuant to 26 U.S.C. S 6672. This provision sets forth the following:
"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 any 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."
If the IRS or state taxing authorities under similar statutes are able to prove that a person is (1) a "responsible person" and (2) acted willfully in failing to collect or pay over withheld taxes, the trust fund penalty may be applied for the portion of the tax not paid. See Davis v. United States, 961 F.2d 867 (9th Cir. 1992). While there are no regulations defining a "responsible person," the term has been litigated comprehensively. The first part of the test is frightening, given that a person is generally said to be "responsible" if a he or she has the authority required to exercise significant control over an entities financial affairs, regardless of whether the individual exercises such control in fact. See United States v. Jones, 33 F.3d 1137, 1139 (9th Cir. 1994).
Hence, the mere signing of a payroll check, or preparing or filing of a payroll tax report, is enough for the Service to attempt to trigger the assessment. Notably, if such a person does everything he or she can to cause taxes to be paid, but those efforts are rejected by those with more control over the business affairs, said parties are arguably not responsible persons. See Alsheskie v. United States, 31 F.3d 837 (9th Cir. 1994). However, it is up to the taxpayer, with his or her lawyer's assistance, to provide evidence at the 4180 hearing sufficient to prove these mitigating factors, as the hearing officers purposefully do not ask questions on Form 4180 aimed at securing that information. The "willful failure to pay" prong of the assessment test is equally alarming, as it can generally be proven by the IRS demonstrating that a person merely paid his own wage or any other business expense when a payroll liability was otherwise due.
The hallmarks of liability assessment are proof of an individual having a majority voting interest, having the ability to hire and fire employees, having financial and management decision-making authority and having authority to sign corporate checks.
The IRS Trust Fund Investigation
The investigation is conducted by an IRS revenue officer. The IRS determines responsibility for the trust fund recovery penalty primarily by (1) reviewing bank signature cards and signatures on cancelled checks and (2) conducting interviews with those believed to have responsibility for the unpaid taxes. A study of the 4180's Section III, "Responsibility," is telling, as the questions therein are not designed to assist the unsophisticated taxpayer in telling the whole story related to that person's responsibility to pay over trust fund taxes from business funds. Rather, Form 4180 is used to snare the person into superficially admitting the bare hallmarks of responsibility mentioned above by essentially checking boxes of admission. Taxpayers are asked to execute Form 4180 under oath, leaving them largely liable for answers that may not have been accurate or complete. As this practice often results in inaccurate liability assessment or over-assessment of taxes or tax periods at issue, it is necessary to temper the form's utility to the IRS by providing supplementary information at every point possible, forcing the revenue officer to include said information within the written form.
Bank Signature Cards and Cancelled Checks
As part of the investigation, the IRS will seek bank statements, bank signature cards, and cancelled checks from the business. In most cases, the IRS revenue officer obtains the banking information by issuing a summons for it directly to the bank. The purpose of obtaining the bank information is to determine who had the authority to direct the tax withholdings to creditors other than the IRS. In the mind of the IRS, signature authority on checking accounts is control over financial decision-making, whether exercised or not. If the IRS finds a signature on a check or a name authorized on a bank card, it will put that person under potential investigation.
However, bank information can be misleading. The real question is not just who had mere signature authority, but who had true effective power and control over the decision-making. The checks are not always the end of the story. Here is an example: A project manager on a construction site who cut checks to vendors on site could be implicated by the numerous checks bearing his signature. But the reality is that the project manager had signature authority for the convenience of the employer at the job site only. He had no say in determining who was paid and when--in other words, no real power. The checks the IRS receives from the bank do not point out these very important and legitimate defenses.
Bank signature cards can also cause minority owners with no involvement in the business to come under IRS scrutiny. For example, take the minority owner in a trucking company who took on minority ownership after getting to know the company from his job selling trucks to the company. He never worked for the trucking company; he had no office there and rarely visited. He signed a few checks for the company--those to pay his employer for the trucks he sold. In cases like this, background work needs to be done to develop facts to explain away the checks. The IRS will not do homework for the taxpayer.
Also wrongfully caught in the IRS crosshairs from bank checks are office managers, secretaries, and payroll administrators. In these situations, it must be established the signatures resulted from paying bills as directed by a superior. Facts must be presented showing the employee did not have the power to determine which creditors would or would not be paid. Writing checks is often a delegated task that lacks any true authority or power over a company's financials. The person delegating the task may be responsible, but the IRS must be made aware that the person to whom it was delegated had no authority.
Interviews with Those Suspected of Being Responsible
The IRS will want to question the individuals it suspects of being responsible, starting with those who have signatures on bank checks and owners, investors, and officers of the business. The questions to be asked are standardized. The revenue officer conducting the interview will use IRS Form 4180 (Report of Interview with Individual Relative to Trust Fund Recovery Penalty or Personal Liability for Excise Taxes). This form is available ahead of time to be reviewed with your client. Here are the questions the revenue officer will focus on:
• Did you determine the financial policy for the business?
• Did you direct or authorize payment of bills?
• Did you open or close bank accounts for the business?
• Did you guarantee or co-sign loans?
• Did you sign or countersign checks?
• Did you authorize or sign payroll checks?
• Did you authorize or make federal tax deposits?
• Did you prepare, review, sign, or transmit payroll tax returns?
Each of these questions on the Form 4180 requires a "yes" or "no" answer. The more "yes" responses, the more the pendulum swings toward responsibility for the trust fund penalty. The potential for liability becomes even greater when "yes" answers are coupled with ownership or holding a corporate office. Beware. This "yes or no" form of response is extremely dangerous to the target of a trust fund investigation. This is where innocent taxpayers get themselves in trouble. This short response format is inconsistent with the practitioner's need to make the IRS aware of exculpatory facts. It is not always as simple as yes or no.
Form 4180 can also cause false positive answers to be given. For example, the question "Did you sign or countersign checks?" could cause someone signing three checks over a two-year period as a convenience to give a correct but misleading answer of "yes." Consider the question, "Did you authorize or sign payroll checks?" It is really a two-part question: (1) Did you authorize payroll checks? and (2) Did you sign payroll checks? There is a big difference between authorizing and signing. Authorizing the checks could show responsibility and control; signing checks can be okay if at the direction of others. But the format permits only one yes or no answer.
A vice president who signed payroll checks only when the treasurer was on vacation might answer "yes" to "Did you authorize or sign payroll checks?" But what if the bills were reviewed in advance by the treasurer and merely handed to the vice president for a ministerial signature? There was no authority, and the checks were signed only sparingly as a convenience. The question does not lend itself to the taxpayer's defense. The Form 4180 interview also requests the interviewee to turn in others--colleagues, investors, family members--who may have been involved in the business. The question asked is: "Who else performed this duty?" "Performing the duty" is not always the same as the control and authority over financial matters. Other individuals can be wrongly implicated if the interviewee lacks a proper understanding of the question. A "yes" to colleagues, investors, and family members when there should be a "no" creates a difficult game of "he said/she said."
If there is one tax notice that every attorney should know the true weight of for their clients' financial well-being, it may very well be a Notice of Intent to perform a Form 4180 Trust Fund Interview. This is an interview that the IRS must attempt to complete before it assesses trust fund penalties against an individual taxpayer who was arguably involved with a business that has outstanding tax liabilities. We regularly encounter individuals who have ignored their notices or, worse yet, attended the IRS Form 4180 interview and signed their acknowledgement and consent to the findings of the interviewer, making them individually liable for trust fund liabilities of their employer or business. The findings that result from the 4180 interview generally cannot be reversed, absent extraordinary breaches in protocol by the IRS. Without planning and counsel present, a taxpayer will more often than not tip the first domino of his or her own trust fund penalty tax nightmare by literally agreeing that the business's tax liabilities will become their own.
Form 4180 is designed to efficiently prove the hallmark factors mentioned above by virtue of the way the questions are asked. The taxpayer is specifically required to check a "yes" or "no" box, with no designated place for explanation. Section III is not queried in a manner which provides any opportunity for explanation as to the frequency, actual responsibility, or true capability to effect the following responsibility factors upon which the Service renders its determination of liability: Did the person participate in the: (1) determination of financial policy; (2) direction or authorizing of payment of bills; (3) opening or closing of bank accounts (4) guaranteeing or co-signing loans; (5) signing or counter signing checks; (6) authorizing payroll; (7) authorizing or making tax deposits; (8) preparing, reviewing or signing payroll returns; and (9) hiring and firing employees?
It is critical that a taxpayer specifically articulates the nature and extent of responsibility as to each factor, making every effort to limit the scope of each factor and to further limit any applicability of a given factor to the specific date range that is applicable to said factor. For instance, where signature authority is an issue, it can often be argued that the signature authority is for convenience only and is rarely, if ever, used. Further, where payroll checks have been written while an owner or operator was unavailable or at the direction of another and otherwise without such authority, it can be argued that the power was exercised on a limited basis and/or that said responsibility should be limited according to the mere singular period at issue and not to broader unpaid trust fund tax periods.
Tactically, going into the interview, the taxpayer should be prepared to articulate the inapplicability of each factor, even where the taxpayer is forced to check the "yes" box, in an effort to limit the applicability of the factor at issue and the time period with which the factor is relevant. To be sure, the lawyer and taxpayer should be fully aware of the factors that the IRS will ask about before the interview. Planning appropriate responses is crucial to contesting the assessment, as revenue officers rarely ask follow-up questions, seeking instead to merely to fill out the form and assess the liability. Where applicable, arguments should be made regarding a client's inability to direct the timing, amount, or choice of payments to creditors, or discussions should occur regarding their inability to engage in management decisions regarding disbursement of funds.
Further, if the taxpayer attempted to protect trust funds and those efforts were frustrated by others with more decision making control, those factors should be presented at the heart of a taxpayer's 4180 defenses. Focusing on facts that show a client had no power to compel or prohibit the payment of certain bills is at the heart of proper advocacy in these hearings. Typical efforts to reduce or limit liability include advising the revenue officer of the limited nature of the taxpayer's controls on every factor, stating who else has each prong of authority, where appropriate, and making sure the limitations to the taxpayer's liability are all contained in the Additional Information section at the back of Form 4180. Further, if a taxpayer can demonstrate that the taxpayer did not willfully or with knowledge fail to pay one or more trust fund liabilities, it will be important to fully explain that evidence to the revenue officer and memorialize those reasons in Form 4180 before executing the form. Finally, making sure to limit the time periods wherein a taxpayer is actually a responsible person can result in huge reductions in the penalty assessment process.
Having an experienced tax lawyer present can prove invaluable, as we have the ability to ask follow up questions to our clients as to each successive Form 4180 question presented by the revenue officer, aiding our clients with their recollection and assisting them with conveying the mitigating factors present in their specific factual circumstances.
Unfortunately, the 4180 interview in which these assessments are made is often done via a surprise visit by a revenue officer, normally after appropriate written notices have been sent and have been ignored by a taxpayer. If a client calls and asks if you if they should participate in a surprise interview which is either about to begin or is already in process, you should advise them to request the ability to reschedule and meet with the Service accompanied by tax counsel at a mutually convenient time. At a minimum, a client should not sign the Form 4180, and request a copy to write in the additional explanations before tendering Form 4180 to the revenue officer at a later agreed upon time.
If the client has already undertaken the interview and signed Form 4180, it will be necessary to see if an assessment has been made, and if not, supplement responses to the interview where possible and always in a signed writing, under oath, by the client. Further, if the assessment has been made, you should determine if appellate periods for assessment have run in order to properly contest the assessments with supplementary responses on appeal where possible. If all else fails, other equitable relief can be sought through processes of reconsideration or offers in compromise requesting that the Service consider relieving liability under the theories of doubt as to liability or doubt as to collectability.
While there are multiple bites at the apple once liability attaches, none is a guaranteed route in correcting improper assessments. The best practice is attempting to keep the client's domino of personal liability upright by taking the time to prepare the taxpayer for the process and using Form 4180 in his or her best interest through preparation and attendance at the interview.