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24 July 2017

How the IRS Weighs “Reasonable” Versus “Reckless” When Payroll Taxes Go Missing

How the IRS Weighs “Reasonable” Versus “Reckless” When Payroll Taxes Go Missing

At face value, it seems the IRS has a very low barrier to personally penalize a member of business management when payroll taxes withheld from employee paychecks (called trust fund money) aren’t submitted to the IRS. Time after time, the IRS seems to win these cases. What it really comes down to is whether the stakeholder knowingly and recklessly disregarded the risk of non-payment. It’s why a Seinfeld icon and soup mogul was recently on the hook for back taxes (read that story here) and why tax practitioners rarely seem optimistic when the IRS claims a trust fund penalty is due. However, a recent case shows there is light at the end of the tunnel and that light is called “reasonable belief.”

Over the years, a series of cases has established that a trust fund penalty is hard to shake. Take these examples, for instance:

  • A president and majority shareholder was found to have recklessly disregarded the risk of non-payment of payroll taxes when he (a) signed loan documents showing that the company had cash flow problems and that it regularly financed the company’s accounts receivables, and (b) was required to personally guarantee a loan to the company. [Rojo, Ernesto In re, (1997, Bktcy Ct FL) 80 AFTR 2d 97-5309, 212 BR 1022, 97-2 USTC]
  • A co-owner/officer of a family landscaping business easily met the recklessness standard when he assumed, without good reason, that tax payments were being made at a time when the business was experiencing severe cash flow issues. He testified that often there was no money to pay him or the other co-owner/officer. [Hayes, Christopher Lawrence In re, (2011, Bktcy Ct MI) 109 AFTR 2d 2012-353 (unpublished)]
  • A responsible party was found to have acted willfully when he paid creditors with funds that the company held in trust for the IRS. It was proven that (a) he knew his CFO—who was entrusted to withhold taxes—had embezzled significant funds and altered and destroyed company records, (b) he was given notice that Form 940 and Form 1120 had not been filed for 19 quarters, and (c) his accountant advised him that he did not have sufficient funds or capital to pay back taxes and creditors. [McCloskey, Timothy v. U.S., (2010, DC PA) 106 AFTR 2d 2010-6916, 2010-2 USTC ¶50682]
  • A court found a corporate officer's responsibility does not begin when he learns the taxes are not being withheld or paid over. The responsibility is inherent in his duty and authority found in the bylaws, exercised authority over financial affairs, and participation in decisions regarding payments to creditors and disbursements of funds.  [Clary, Moodye v. U.S., (1996, DC NC) 77 AFTR 2d 96-1128, 96-1 USTC ¶50150]

However, a recent ruling by the Court of Appeals for the Sixth Circuit [Byrne, (CA 6 5/15/2017) 119 AFTR 2d ¶ 2017-1824] has raised the threshold of what the IRS considers “reckless disregard.” While the appeals court agreed with its district court that the business owners were responsible for payroll tax payments, it disagreed that the parties recklessly disregarded that responsibility. The parties acted on letters sent by the IRS by responding, hiring a CPA firm to conduct an audit, and hiring an assistant comptroller and a chief financial officer to support the controller directly responsible for paying the taxes for the company. The audit did not detect accounting irregularities and they believed their controller when he said he had begun to pay the trust fund taxes on time.

Sounds reasonable, right? The appeals court thinks so, too. The court said that, while it was not holding that responsible persons may escape liability simply because they hired support staff or other officers to review payment of trust fund taxes, these were important considerations in determining whether the business owners reasonably believed the company was making timely payment of trust fund taxes.

Only time will tell whether the ruling will open the door for a more measured judgement on what the IRS considers reckless versus reasonable. One thing is for sure: When the IRS assesses a trust fund penalty due to non-payment of payroll taxes, it’s important to get the right experts on your side who can help you put your best foot forward.

Image Copyright: archerix / 123RF Stock Photo


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