Taxes are often neglected when a business is having financial difficulties. This can have serious repercussions for the business and the individuals who are responsible for having taxes withheld and remitted to the IRS. The IRS has the ability to assess trust fund recovery penalties against these individuals, which essentially makes the business tax liability a personal tax liability for the individuals. The recent Arriondo v. United States, No. H-14-2734 (S.D. Texas 2016), case provides an example.
The Facts and Procedural History
Mr. Arriando was the president and CEO of American Steel Building Company, Inc. He did not own the company. American Steel faced financial challenges due to the economic downturn in 2008.
Mr. Arriando generally relied on his director of finance to withhold and remit taxes to the IRS. Mr. Arriando did not ask to see payroll tax deposits and did not ask to see any evidence that the taxes were being paid, although he could have.
When the director of finance left the company, her successor informed Mr. Arriando that had been using employee payroll tax trust fund money to pay creditors rather than the IRS and had been writing checks but not releasing them.
The director of finance had instructed her employees not to pay federal withholding taxes to the IRS.
When Mr. Arriando learned of this, he began shutting down the business.He continued to pay his employees and himself and made at least one purchase in an effort to make a profit for the business after he learned about the unpaid taxes.
The IRS assessed $365,537 in trust fund recovery penalties against Mr. Arriando.
Trust Fund Recovery Penalty
Employers are required to withhold income taxes from their employees’ wages. The penalties for failing to withhold taxes and for failing to remit the taxes to the IRS is severe.
Section 6672(a) imposes a penalty equal to the entire amount of the unpaid taxes if the employer fails to pay the taxes to the IRS. This penalty is commonly referred to as the trust fund recovery penalty.
To be subject to the trust fund recovery penalty, the taxpayer has to be a responsible person and has to willfully fail to collect, account for, or pay over the taxes.
The term “person” includes “an officer or employee of a corporation, or a member or employee of a partnership who as such officer, employee, or member is under a duty to perform the act in respect of which the violation occurs.”
The Code imposes liability on any person who is required to collect, truthfully account for, or pay over the withheld taxes and willfully fails to do so. Involvement in either collecting, truthfully accounting for, or paying over taxes is sufficient; liability is not limited to those persons in a position to perform all three duties.
In Arriando, Mr. Arriando agreed that he met this requirement. He was the CEO and had the ability to be involved in and ultimately responsible for the withholding and submission of payments to the IRS.
Responsibility is a matter of status, duty, power and authority. It is not necessary that an individual have the final or exclusive word as to which creditors should be paid in order to be subject to the trust fund recovery penalty. In fact, as the court noted in Arriando where Mr. Arriando did not initially know about the unpaid taxes due to the actions of his director of finance to conceal them, one need not even have knowledge that he has such authority.
There are six factors that the courts consider in determining whether a person is responsible for the trust fund recovery penalty. These factors ask whether the person:
- is an officer or member of the board of directors,
- owns a substantial amount of stock in the company,
- manages the day-to-day operations of the business,
- has the authority to hire or fire employees,
- makes decisions as to the disbursement of funds and payment of creditors, or
- possesses the authority to sign company checks.
No one factor is determinative. In Arriando, the court concluded that all but the second factor applied to Mr. Arriando. The court also noted that there can be more than one responsible person. Thus, the finance director may have been more culpable, but this was not a viable defense to the trust fund recovery penalty for Mr. Arriando.
The responsible person’s failure to collect or account for or pay over taxes must also be willful in order for the trust fund recovery penalty to apply. The court in Arriando considered these facts in determining that Mr. Arriando had acted willfully: the business paid creditors other than the IRS after he knew of the unpaid taxes, paid employees and Mr. Arriando, and paid at least one third party in an effort to generate more income for the business.
Having concluded that Mr. Arriando was a responsible person and acted willfully, the court upheld the trust fund recovery penalty determination.
The Takeaways from Arriando
The IRS has the ability to assess trust fund recovery penalties for those who are responsible for not paying payroll taxes to the IRS. This makes a business tax liability a personal tax liability.
The trust fund recovery penalty is a severe punishment. The penalty amounts can be and often are quite large. Given the severity of this penalty, in many cases, it is advisable to immediately cease business operations rather than continue to operate the business with a hope that the business will turn around. If the business is to be continued, other parties should not be paid before the IRS is paid.