One of the most important financial responsibilities for any business is the timely payment of taxes, including payroll taxes.
Payroll taxes are the taxes that employers withhold from their employees’ paychecks and then submit to the government on their behalf. They also include the employer’s portion of the tax.
While some businesses may be tempted to use these funds to manage their cash flow issues, doing so can have serious financial and legal consequences. Using payroll taxes as a form of “government loan” can seem like an attractive option for businesses that are experiencing cash flow problems. However, this practice is illegal and can result in severe penalties, including fines, interest, and even criminal charges. In addition to legal repercussions, this can also harm the company’s reputation and relationship with its employees, as payroll taxes represent their contributions to Social Security, Medicare, and other benefits.
The consequences of mismanaging payroll taxes can escalate quickly. If a business fails to pay payroll taxes, the government can place a tax lien on the company’s assets, which means they can seize the business’s property to satisfy the debt. Additionally, the IRS may pursue personal liability against the company’s owners or officers for unpaid taxes, which can result in significant financial and legal consequences.
The recent Hart v. Commissioner, 19120-12 court case provides an example of this.
Facts & Procedural History
The taxpayer worked for a real estate firm. The firm did not pay its payroll taxes. The IRS responded by assessing a trust fund recovery penalty against the taxpayer.
The taxpayer did not file a protest to contest the assessment. However, she did file a collection due process hearing request after the IRS attempted to collect the penalty from her. The IRS would not let her challenge the penalty during the hearing.
While the appeal was pending, the taxpayer obtained a judgment against the owner of the real estate firm in the amount of the penalty assessed against her.
The taxpayer asked the IRS to hold the collection appeal to give her time to execute her judgment against the real estate firm. The IRS refused to do so. Litigation ensued.
The trust fund taxes were paid by the time the tax court considered the taxpayer’s case. But the taxpayer had not yet been able to collect on her judgment against the real estate firm owner.
About Trust Fund Taxes
The so-called trust fund taxes fund Social Security and Medicare. As noted, employers are responsible for withholding these taxes from their employees’ wages and submitting them to the government on their behalf. The other portion is paid by the employer directly.
The term “trust fund” refers to the withheld portion as these taxes are held in trust by the employer until they are remitted to the government. The employer is acting as a trustee for the government with respect to these funds.
Under the law, employers who fail to remit trust fund taxes are fully liable for the unpaid amounts, and the IRS has broad authority to collect these taxes. The IRS may assess a trust fund recovery penalty (“TFRP”) against responsible persons for the unpaid taxes.
“Responsible persons” generally include those who have significant control over the company’s finances, such as owners, officers, and other top-level executives. However, the definition of a responsible person is not limited to these individuals and may also include lesser employees who have the authority to make financial decisions for the company, such as bookkeepers.
The TFRP is equal to 100% of the unpaid trust fund taxes and can be assessed against each responsible person individually. This means that if multiple individuals are found to be responsible for the unpaid taxes, each person can be held liable for the full amount of the penalty. Put another way, the IRS can assess the penalty and then start collections from the responsible person’s personal assets.
Trust Fund Penalty Disputes
When trust fund controversies arise involving responsible persons who are not the business owners, the non-owners may be tempted to turn over or disclose employer records or assets or even identify other responsible persons and their personal assets.
This is often a viable strategy because it is the IRS’ policy to assess the trust fund penalty on multiple taxpayers, but to collect the trust fund tax only once. By identifying other responsible persons and their assets the informer may be able to avoid paying the TFRP personally.
Non-owner employers may also find this course of action necessary to prevent the employer from taking steps to shift the tax liability to the non-owner employee.
There are a number of ways that employers try to shift liability to non-owner employees. For example, employers may promise to pay the tax by entering into a settlement agreement or an offer-in-compromise for less than the full amount of tax owed. In the event that the settlement or offer is accepted, it is likely that the IRS will then pursue the non-owner employee for the remainder of the unpaid tax liability.
Similarly, employers may promise to pay the tax by agreeing to an installment agreement with the sole aim of buying time to conceal assets. Once the assets are sufficiently concealed the employer may simply go out of business, leaving the non-owner employee on the hook for the remaining unpaid taxes.
Employers may also attempt to halt the IRS’s collections efforts with the aim of encouraging the IRS to pursue the employee before the assessment and/or collections statute of limitations expires as to the employee. Employers may be able to do this by requesting a collections due process (“CDP”) hearing at a time when the CDP hearing will not begin before the assessment and/or collections statute of limitations for the employee runs.
Employees Can Fight Back
But savvy non-owner employees are not helpless in these situations. They can fight back by taking steps to halt the collection process against themselves or by agreeing to extend the tax assessment or collection period against themselves so that the IRS is not under a time constraint to collect the tax from them before the deadline expires.
Moreover, they may even pursue civil suits against the business and the business owner for recovery of the taxes that they paid or will have to pay.
These types of procedural battles are often inevitable due to the business and the business owner undergoing financial difficulties and the non-owner employees not wanting to pay the business’s tax liability personally.
Perhaps this would be different if the business or business owner was in a position to simply agree to pay the trust fund and/or the TFRP. But the business’s financial difficulties are typically why these types of disputes arise in the first place.
These disputes involve multiple taxpayers each of whom pursues multiple tax and non-tax administrative and judicial remedies. These tax disputes can play out over more than a decade. In the end, these types of procedural battles are lengthy and costly for all parties involved, often result in the government not collecting the taxes that are owed, and take up too much of the IRS’s and the court’s limited resources.
Trust fund penalty cases are serious business. Payroll taxes are serious business. If the business runs into financial trouble, those in control of the business should talk to an experienced tax attorney. As in this case, the IRS is not likely to grant additional time to recover funds or wait for the business to recover. This does not mean that the business cannot use the IRS administrative process to buy this additional time. The taxpayer in the current case seems to have used the process for this very purpose.