Employment taxes can be deadly for businesses. Once a business gets behind, it can be impossible to catch up.
Those operating a failing or struggling business may feel that using employment taxes as a short-term loan from the IRS is justified. The thinking may be that they are needed to keep employees employed, to save jobs, and to keep trusted colleges and vendors going. They may feel that the business can simply catch up at some point and make things right with the IRS.
These types of tax debts can also come up if the business misclassifies employees.
There are quite a few court cases where the businesses have not caught up. The result is often a trust fund recovery penalty imposed on those operating the business. Our tax laws allow the IRS to assess this penalty against those who are “responsible” for the business not paying over employment taxes.
As the Cashaw. v. Commissioner, T.C. Memo. 2021-123, case shows, this penalty can shift the business’ tax liability to a personal tax liability for those who work at the business. This is even true if the persons operating the business do not own the business, which was the case in Cashaw.
Facts & Procedural History
The plaintiff had formerly worked for Riverside General Hospital in Houston, Texas. The hospital has a long history in Houston. It served the underserved population in the Third Ward in Houston. Third Ward is the center of Houston’s African American community.
The hospital was in financial trouble in the early and mid-2000s. This was in part due to the former hospital administrator’s Medicaid fraud. The Federal government failed to make its Medicaid payments to the hospital given the fraud, which resulted in the hospital not being able to pay its creditors timely.
The hospital’s creditors filed suit. This resulted in Rule 11 agreements obligating the hospital to divert funds to the creditor (a Rule 11 agreement refers to a written agreement between the parties to litigation in Texas state courts).
Given the plaintiff’s efforts and long tenure at the hospital, she was appointed as the temporary chief administrator when the former administrator was removed. After being appointed, the plaintiff made decisions to pay certain creditors and to preserve funds to provide patient care. These payments were made, even though employment taxes were not being paid over to the IRS at the time.
The plaintiff stopped working for the hospital and, later, the IRS assessed a trust fund penalty against her for the unpaid employment taxes. The plaintiff timely filed a request for a collection due process hearing and at the hearing, she challenged her liability for the trust fund penalty. The IRS Office of Appeals adjusted the penalty amount for some periods but sustained the penalty for other periods.
The plaintiff then filed suit in the U.S. Tax Court to challenge the penalty determination.
About the Trust Fund Recovery Penalty
Employees are not liable for employment taxes that are withheld by employers, but not paid over to the IRS by employers. The employers do not get this free pass. Instead, our tax laws provide a penalty for the employer.
This “trust fund recovery penalty” allows the IRS to recoup the unpaid taxes from the employer. More specifically, it allows the IRS to recoup part of the taxes from those who are in control of the employer. This is usually the owner of the business. For larger businesses, this may also include the CEO, CFO, etc. This makes the business tax problem an individual tax problem.
The trust fund recovery penalty is assessable against any “responsible person.” The responsible person is basically anyone who has control over the business. It is the person or persons who have the ability to say which creditors, including the IRS, get paid. To the IRS, this means anyone who signs the business checks, for example.
The Willfulness Requirement
Section 6672 includes a willfulness requirement. To be liable for the trust fund recovery penalty the individual has to have acted willfully. This means “a voluntary, conscious and intentional failure to collect, truthfully account for, and pay over the taxes withheld from the employees.”
In this case, the plaintiff admitted that she caused the hospital to pay some other parties rather than the IRS. This included payments required to be made pursuant to the Rule 11 agreement and payments needed to continue providing care for patients. The court addressed both types of payments.
For the payments pursuant to the Rule 11 agreement, the court concluded that this type of litigation agreement is nothing more than a private contract. It did not give the creditors priority over the IRS. This is consistent with court cases which even say that repaying monies advanced as a loan to the business is not sufficient. It does not appear that the parties asked the state court to enter an order to enforce the agreement. The court might have been willing to do this, if requested. With hindsight it might have been advantageous to have such an order for purposes of this penalty. The trust fund recovery penalty was probably not being considered at the time given the circumstances.
For the payments needed to continue to provide care for patients, the court reached the same conclusion. The plaintiff cited Texas statutes and argued that they subjected her to civil and criminal liability if she failed to pay for “essential services” as provided by hospital staff, vendors, and creditors. The court concluded that these statutes did not impose individual liability. It also noted that the Federal trust fund recovery penalty statute would preempt any state statute.
This case is important as it is one of very few cases where the courts have extended the trust fund recovery penalty to an employee who basically had nothing to gain from not paying employment taxes. Unlike a business owner (or the business owner’s spouse), a mere employee might not get a significant benefit from the interest-free loan from the IRS by not paying over employment taxes.
This case is also important in that it touches on the nature of Medicaid and adds another case that rejects the concept of essential care. The Federal government often pays its bills late. It often fails to pay at all. There are numerous instances where it has not lived up to its obligations, which lead to liability in other areas. It is not clear whether the late payments to the hospital were justified; however, it is an almost certainty that the Federal government was behind and delayed on legitimate payments as that is its normal course of conduct with respect to these payments. Regardless, this case is another rejection of the “essential care” type of argument for employment taxes. This angle might be a justification for “reasonable cause,” which is available as a defense to these penalties in Texas.