Most small business employees never expect to be personally liable for their employer’s tax obligations. Bookkeepers may find themselves facing IRS collection actions for trust fund taxes they never controlled for the business. This is on the basis of the bookkeeper being a “responsible person” for payment of the payroll taxes.
How do courts determine who truly qualifies as a “responsible person” for employment taxes? The recent Tax Court decision in Kazmi v. Commissioner, T.C. Memo. 2022-13, provides an example where the IRS pursued a part-time bookkeeper for substantial penalties despite his apparent lack of financial authority. This case gets into the difference between administrative duties and true financial responsibility.
Contents
Facts & Procedural History
Kazmi worked as a part-time hourly bookkeeper for an urgent care center. The business was an Illinois entity taxed as a Subchapter S corporation. It was wholly owned by a doctor.
The court described Kazmi’s limited role: he had no ownership interest, held no officer position, wasn’t named on any company bank accounts, lacked check-signing authority, and possessed no ability to make payments on behalf of the company. He simply worked under the doctor’s direction at all times.
During an IRS trust fund penalty interview, Kazmi completed Form 4180, indicating his job title was “bookkeeper” with duties “to take care of payroll.” He acknowledged being authorized to transmit payroll tax returns and make federal tax deposits, but stated he had no authority to determine financial policy, authorize bill payments, or authorize payroll.
The revenue officer completed Form 4183, recommending trust fund penalties against Kazmi primarily because he was “one of the corporation’s bookkeepers and current [power of attorney].” When the company failed to pay employment taxes for quarters ending June 30 and September 30, 2014, the IRS pursued Kazmi personally.
The IRS sent Kazmi a Letter 1153 proposing trust fund penalties. Though he received this letter, he didn’t file a protest within the 60-day window. The IRS assessed the penalties and later filed a Notice of Federal Tax Lien. Kazmi then requested a Collection Due Process hearing, where the doctor-owner submitted a letter stating Kazmi had no responsibility for tax obligations and only performed tasks assigned by the owner.
The settlement officer determined Kazmi couldn’t challenge the underlying liabilities because he had a prior opportunity when he received Letter 1153. The officer sustained the IRS Tax Lien, leading Kazmi to petition the Tax Court.
About the Trust Fund Recovery Penalty
The trust fund recovery penalty addresses a specific tax problem: employers who withhold taxes from employee paychecks but fail to remit those funds to the government. These withheld amounts are considered held in “trust” for the IRS.
When businesses face financial difficulties, they sometimes use these trust fund taxes as working capital. Since the IRS has already credited employees for these withheld amounts, the government would otherwise bear the cost of this non-compliance. This happens frequently during tax audits and other enforcement actions.
Section 6672 of the tax code creates personal liability for “responsible persons” who willfully fail to pay these trust fund taxes. The penalty equals the total amount of unpaid trust fund taxes, and unlike many tax assessments, can be assessed without first issuing a notice of deficiency. This means affected taxpayers must be vigilant about IRS notices and deadlines.
The Responsible Person
The trust fund recovery penalty applies only to individuals deemed “responsible persons” who willfully failed to pay the taxes. Courts have developed specific factors to identify responsible persons.
The Seventh Circuit, which would have jurisdiction over an appeal in Kazmi’s case, looks for these indicators:
- Holding corporate office
- Owning stock in the company
- Serving on the board of directors
- Having authority to sign checks
- Having control over corporate financial affairs
As the court noted, whether someone is a responsible person is “a matter of status, duty and authority, not knowledge.” The critical question is whether the person had actual power to decide which creditors get paid.
For Trust Fund Recovery Penalty Disputes, the IRS often assesses penalties against multiple individuals, creating a situation where each person hopes the IRS will collect from others first. This strategy puts financial professionals like bookkeepers at particular risk, even when they lack decision-making authority.
When Is a Failure to Pay “Willful”?
Beyond responsibility, the tax code requires willfulness in the failure to pay taxes. Courts define willfulness as a “voluntary, conscious and intentional failure to collect, truthfully account for, and pay over the taxes withheld from employees.” No evil intent or desire to defraud the government is required.
Willfulness typically exists when a responsible person pays other creditors while knowing employment taxes remain unpaid. Even reckless disregard of a known risk that taxes might go unpaid can constitute willfulness under prevailing case law.
This standard creates significant exposure for anyone involved in business finances, regardless of their actual control over financial decisions. Small business financial staff should understand these risks when handling Payroll Tax Disputes.
Collection Due Process Hearings
Congress created Collection Due Process hearings to give taxpayers a second review before the IRS completes collection actions. These proceedings apply when the IRS files a lien or imposes a levy against a taxpayer.
The IRS Office of Appeals handles these hearings and must verify that IRS procedures were followed. If the taxpayer disputes the underlying liability, Appeals must also verify that the liability is correct.
However, the law specifically prohibits taxpayers from challenging their underlying liability if they previously had an opportunity to dispute it. This limitation prevents multiple challenges to the same assessment and promotes finality in tax matters.
Kazmi’s Legal Challenge
Kazmi maintained he wasn’t a responsible person and lacked willfulness—essentially arguing the IRS targeted the wrong person. His case featured compelling facts: he was merely a part-time bookkeeper with no ownership interest, no officer status, no check-signing authority, and no control over company finances.
However, Kazmi faced a significant procedural barrier. Because he received Letter 1153 but didn’t appeal it, the Tax Court held he couldn’t challenge the underlying liability during his CDP hearing. The court had to apply an abuse of discretion standard, which is much more deferential to the IRS than a full review of the merits.
Kazmi argued that Letter 1153 shouldn’t constitute a “prior opportunity” since taxpayers can’t seek Tax Court review if their Letter 1153 appeal is denied. The court acknowledged this limitation but noted taxpayers can still obtain judicial review through refund litigation—by making a small payment, filing a refund claim, and suing in district court if denied.
The court declined to overturn its precedent regarding Letter 1153 as a prior opportunity, meaning the IRS determination would stand unless shown to be arbitrary, capricious, or lacking sound basis. This procedural misstep ultimately prevented Kazmi from obtaining relief despite his compelling factual case.
The Role of IRS Personnel in the Process
This case highlights how different IRS functions contribute to trust fund penalty determinations. The revenue officer, appeals officer, and IRS attorney all had opportunities to correct what appears to be an erroneous assessment.
The IRS Appeals Office has particularly broad powers to remedy errors or address inequities. As the court observed, this case arguably should have been resolved administratively rather than proceeding to litigation.
The revenue officer’s decision to propose penalties against Kazmi appears largely based on his status as a bookkeeper with a Form 2848 power of attorney for the business. This form allowed him to act on behalf of the company for payroll taxes but didn’t grant him actual decision-making authority over which bills to pay.
IRS attorneys also have substantial discretion to ensure justice is done, balancing their duty to represent the agency with their obligations to the public. In this case, the court suggested all three IRS functions—revenue officer, appeals officer, and counsel—failed to properly assess Kazmi’s actual responsibility.
The Takeaway
The Kazmi case serves as a warning for financial employees who lack true decision-making authority. Simply having a Form 2848 power of attorney for a business can create an appearance of responsibility that might trigger trust fund recovery penalties, even when the individual lacks actual control over finances.
For bookkeepers, accountants, and other financial professionals, the safest approach is to clearly document limitations on their authority, carefully consider before becoming a power of attorney for tax matters, and always respond promptly to any IRS penalty notices—even when the IRS appears to have targeted the wrong person.
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