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The Internal Revenue Code requires persons other than taxpayers to function as withholding agents for collecting certain taxes for the IRS. Section 6672 of the Internal Revenue Code provides that any person who is required to collect, truthfully account for, and pay over any tax imposed under the Code — and who willfully fails to do so or willfully attempts to evade or defeat such tax — is liable for a penalty equal to the total amount of the tax not paid over to the government. 26 U.S.C. § 6672(a). This penalty is frequently referred to as the "Trust Fund Recovery Penalty" because the persons on whom liability is imposed are deemed to have held the unremitted taxes "in trust" for the IRS.
When a corporation fails to transmit "trust fund" payments when due, an IRS revenue officer may be assigned to investigate the company and to interview potentially responsible officers to determine individual responsibility for the business’s financial affairs in addition to the collectibility of the unpaid taxes from corporate assets. Since persons summarily determined to be "responsible" are given notice of the proposed assessment of the Trust Fund Recovery Penalty and advised of their right to file a formal "protest" of the assessment with the IRS Appeals Division, it is crucial for a corporate officer to obtain knowledgeable tax counsel prior to any exposure to investigatory activity, which may begin with an apparently innocuous telephone call during which meticulous self-serving memoranda are compiled. Unless the revenue officer loses interest in that individual, the corporate officer is likely to have a heightened need for expert tax counsel during the protest and appeals hearing process, and, more likely than not, in federal court proceedings seeking to reverse the imposition of the penalty.
Liability under 26 U.S.C. § 6672 attaches if an individual meets two requirements: (1) he or she must be a "responsible person"; and (2) he or she must "willfully" fail to pay over to the government the amount of taxes otherwise due.
Liability under Section 6672 subjects all persons considered "responsible" for the collection and payment of taxes to a penalty equal to the amount of the taxes due when the company fails to turn over such funds to the government. A "responsible" person under Section 6672(a) is a person required to collect, truthfully account for or pay over any tax. Responsibility is a matter of status, duty, or authority, not knowledge. A responsible person must have significant control over the corporation's finances, although that control need not be exclusive.
Generally, the determination of whether the requisite responsibility exists is generally considered in the context of the person's authority over a company's finances or general decision-making. The responsible person is viewed as the person who determines the order of payment to creditors or one who has significant control over the disbursement of funds and who has the power to —and who effectively is, the one with the power to — control the decision-making process by allocating corporate funds to other creditors in preference to its withholding tax obligations.
For purposes of Section 6672, Section 6671, 26 U.S.C. § 6671 defines a "person" to include 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 courts have held that the listing of persons in 26 U.S.C. § 6671(b) is not exclusive, however. Courts have stated, for example:
The term "person" is to be construed to include all those connected with a corporation so as to be responsible for the performance of the act in respect of which the violation has occurred. Liability is not limited to those employees performing merely mechanical functions of collection and payment, but extends to all with responsibility and authority to avoid the default which constitutes a violation of the statute; even though more than one person may be liable.
Generally, the test applied for determining responsible person status essentially is a functional one, focusing upon whether the individual exercises control over the financial affairs of a business and, specifically, disbursements of funds and priority of payments to creditors. Simply holding corporate office does not make an individual a "responsible person," although corporate officers at all levels are likely targets for the penalty. Ultimately liability attaches only to those who participate in decisions concerning payment of creditors and disbursal of funds. A person is responsible under § 6672 if he or she controls the decision making process by which the corporation allocates funds to other creditors in preference to its withholding tax obligations to the IRS.
For the IRS to successfully assert the Trust Fund Recovery Penalty against a "responsible person," the responsible person's failure to collect, account for, or pay over the trust fund taxes must have been "willful." Mere negligence will not constitute willfulness under the statute. Rather, courts have held that "willfulness may be established by a showing of gross negligence involving a known risk of violation."
At a minimum, therefore, the willfulness element denotes "a reckless disregard for obvious or known risks" and the failure to pay withholding taxes must be "voluntary, conscious and intentional-as opposed to accidental."
In determining whether a responsible person's actions are reckless, the courts consider all relevant factors, taking a "totality of the circumstances" approach.
This area of federal tax law is particularly troublesome because the deck is stacked against any corporate officer caught in the huge "dragnet" used by the IRS when taxes supposed to be held in trust and delivered on time are never recelved. The IRS approach is to find all potential targets guilty until proven innocent and a single IRS employee's hasty recommendation to impose the penalty is difficult to overcome. Unlike its function in other areas of tax procedure, the IRS Appeals Division tends to act as a "rubber stamp" in Trust Fund Recovery Penalties. Even worse, the U.S. Tax Court has no jurisdiction to hear Trust Fund Recovery Penalty matters. This means the taxpayer who wants to fight the unfair imposition of Trust Fund Recovery Penalty liability is generally required to seek relief in the Federal District Court or the Court of Federal Claims, which will be permitted only after paying all or an acceptable portion of the disputed tax. In the more questionable cases, it may be possible to proceed by way of an Offer in Compromise based on Doubt As To Liability ("DATL"). A great deal of finesse is required to achieve an acceptable outcome in these matter.
Philadelphia tax attorney Joseph R. Viola has effectively handled a significant number of Trust Fund Recovery Penalty cases and has devoted a great deal of study to this area of tax law. If you receive an indication from an IRS representative, whether by telephone or letter, that you are being considered a potential source for payment of outstanding payroll or excise taxes owed by your company, contact Joe Viola for an immediate face-to-face consultation before taking to anyone at the IRS. This is an area where forthrightly insisting that you have nothing to hide amounts to playing into the government's hands. You may or not be liable for the penalty — but that determination is made at the outset using a "check the boxes" approach and may take a great deal of time and money to undo.