Court Upholds $4.3 Million Responsible Person Penalty
Background
Employment tax noncompliance can result in significant penalties.
As outlined in the case, under Internal Revenue Code (“IRC”) §6672, a Trust-Fund Recovery Penalty (“Penalty”) can arise when the following occurs: “Employers are required to withhold their employees’ share of Federal Social Security and income taxes from the employees’ wages. The employer holds these “trust fund taxes” in trust for the benefit of the United States. In order to ensure that the taxes are remitted to the United States, IRC §6672 imposes a penalty equal to the entire amount of the unpaid taxes: “Any person required to collect, truthfully account for, and pay over any tax imposed by this title who willfully fails to collect such tax, or truthfully account for and pay over such tax, or willfully attempts in any manner to evade or defeat any such tax or the payment thereof, shall, in addition to other penalties provided by law, be liable to a penalty equal to the total amount of the tax evaded, or not collected, or not accounted for and paid over.”
Accordingly, the liability under IRC §6672 is composed of two elements including (1) that the taxpayer was a “responsible person”; and (2) that the taxpayer willfully failed to collect, account for, or pay over such taxes.
The Penalty can be assessed against any responsible person required to collect, account for, and pay over taxes held in trust who willfully fails to perform any of the activities. This Penalty may be imposed for:
- Failure to collect tax;
- Failure to account and pay tax; or
- Willful attempt to evade or defeat a tax.
A responsible party is a person(s) who has the duty and power to direct the collection, accounting, and paying of trust fund taxes. Such person may be:
- An officer or an employee of a corporation or partnership;
- A corporate director or shareholder;
- A member of a board of trustees of a nonprofit or healthcare organization;
- Another corporation or third party payer;
- Payroll service providers; or
- Professional employer organizations.
The Penalty imposes a personal assessment equal or up to 100% of the employment tax that was withheld and not paid, or that should have been withheld. Thus, the business remains liable for the employment taxes; however, the “responsible person” for which a Penalty has been assessed can also be held liable. Therefore, the Internal Revenue Service (“IRS”) can satisfy the liability using the taxpayer’s business or individual assets. In addition, the Penalty is not dischargeable in bankruptcy.
The Case
In the case of Robert L. McClendon v United States of America, the physician owned a failing family practice, a healthcare business that provided medical services. Dr. McClendon discovered his practice’s Chief Financial Officer (“CFO”) embezzled more than $10 million in payroll and other withholding taxes. The CFO eventually plead guilty to three counts of felony theft of money charges in the case. However, his admission of guilt did not alleviate Dr. McClendon from being implicated in the tax fraud.
The practice eventually ceased operations and paid its remaining receivables to the IRS towards payment of the debt owed to the IRS. In addition to these funds, Dr. McClendon made a $100,000 loan to the practice. As noted in the case memorandum and opinion these funds were “for the restricted purpose of….using the funds to pay the May 15, 2009 payroll”. Accordingly, the practice used the funds to pay its employees.
The IRS assessed a “responsible person” penalty against Dr. McClendon declaring that his failure to pay was willful. Dr. McClendon offered that, although he was a responsible person, his failure was unintentional. Despite the physician’s claims, the IRS assessed him with a $4.3 million responsible person penalty. Dr. McClendon paid a small part of the balance and then sued for a refund and abatement of the remaining penalty amount. His motion for reconsideration claiming that the liability should only be for the $100,000 as a preferential payment to cover payroll was denied. The court recently upheld the decision claiming that “the business lacked sufficient unencumbered funds to cover the tax liability.”
Conclusion
It is important to note that, individuals can be considered a “person” responsible for withholding, accounting for, or depositing or paying specified taxes including nonresident alien withholding and employment taxes, and that willfully failing to do so can cause the individual to be held personally liable for a penalty equal to the full amount of the unpaid trust fund tax, plus interest.
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