IRS Denied Trust Fund Recovery Penalties Against “Errand Boy” Employee

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Imagine working as an employee for a company for two years and then having the IRS impose trust fund recovery penalties worth more than 10 times your annual salary. That’s exactly what happened in Powell v IRS, but when it came time for trial, the United States District Court for the Western District of Pennsylvania said the employee was more like an “errand boy” than a responsible person who could be held liable for the company’s failures to withhold and pay taxes.

Employers Have a Duty to Withhold and Pay Taxes for Their Employees

Employers with United States taxpayer employees are required to collect, truthfully account for, and pay certain payroll-related taxes to the IRS on their employee’s behalf. This includes:

  • Income tax
  • Federal social security tax
  • Medicare tax
  • Federal and state unemployment taxes

If they don’t, the IRS can impose what’s called “trust fund recovery penalties” since the funds deducted are held in trust for the employees until the funds can be deposited with the IRS in payment of the payroll taxes due. The penalty for willfully failing to collect and pay over trust fund taxes equals the total amount of the taxes not collected or paid – for all the employees of the company.

IRS Imposed Trust Fund Recovery Penalties Against Company Employee

Trust fund recovery penalties aren’t necessarily imposed against the company as the employer. The IRS has the authority to issue penalties against any “responsible person” in the company as an individual. This penalty “pierces the corporate veil” and can be used to hold shareholders, officers, and business owners personally liable for payroll taxes that should have been withheld automatically but went unpaid while the funds that should have been earmarked for payroll tax deposits were diverted to other uses. The result is the same whether the funds were used to pay legitimate business expenses or misappropriated for personal use. Courts presume that these assessments were issued against the right person unless the taxpayer can prove they are not a “responsible person” at the company.

Identifying the “responsible person” isn’t always easy. Different corporate structures and complicated organizational charts can obscure whose job it truly is to withhold and file payroll taxes. Maybe that is why, in the case of Michael’s Automotive Services (MAS), the IRS imposed more than $400,000 in trust fund recovery penalties against an employee who had signatory authority over a single bank account.

MAS failed to pay any payroll taxes for its employees between May 31, 2005 and December 31, 2007. During that time, one employee, Richard Powell, Jr., had acted as a kind of personal assistant to the business’s owner, Michael Pavlock. His wages from the company were modest: around $29,000 in 2006 and $35,000 in 2007. While Powell would go on to own other businesses with Mr. Pavlock through “sweat equity,” his role at MAS was quite limited. But that didn’t stop the IRS from issuing Trust Fund Recovery Penalties against him.

After the IRS seized $225 to put toward the penalties, Powell sued to recover the funds and have the assessment overturned. The IRS counter-sued, demanding the rest of its penalties be paid in full. When the matter came to trial, there were two questions:

  1. Was Powell a “responsible person” liable for the trust fund taxes under the statute?
  2. Did Powell willfully fail to withhold or pay those taxes?

Who is a Responsible Person for Trust Fund Recovery Penalties?

A responsible person under the relevant law is anyone “required to collect, truthfully account for or pay over any tax due to the United States.” The person must have significant control over the company’s finances, and significant or final say over which bills and creditors get paid. This is a question of the person’s status, duty, and authority within the company, not their knowledge of the tax obligations. In deciding whether a party is a “responsible person,” the federal courts will consider:

  • Company by-laws
  • The person’s signatory authority over company bank accounts
  • Whether the person had signed federal employment or tax returns
  • Payment to other creditors in lieu of the IRS
  • Who the company’s officers, directors, and principal shareholders are
  • Whether the person has the authority to hire and fire employees
  • Who is in charge of the company’s financial affairs.

The District Court heard testimony from Mr. Powell, the employee against whom the penalties were issued, and Mr. Pavlock, the business owner, along with the company’s president, accountant, and a managing member of a firm that funded the company. The Court found that Mr. Pavlock’s testimony that Powell was a responsible person at the company was “not credible” and “self-serving” and said that Powell was more of an “errand boy” than a general manager because:

  • The accountant and the company president testified that Mr. Pavlock was responsible for filing tax returns and making tax payments
  • Pavlock supervised MAS employees including Powell
  • The president testified “there was not much democracy” at the company and Pavlock’s decisions were final.
  • No one could remember Powell’s job title or duties
  • The accountant said Powell seemed like a manager but got paid like an employee
  • Powell’s job consisted of running errands for Pavlock and completing tasks he assigned him
  • No one remembered Pavlock discussing taxes or finances in meetings with Powell
  • Powell never gave any financial reports
  • Powell’s signatory authority on one of MAS’s bank accounts was to allow him to buy parts at Pavlock’s direction
  • Powell did not open company mail
  • He was not a shareholder, stockholder, or capital contributor to the company
  • He did not have the ability to hire or fire employees, enter contracts, or make financial decisions for the company
  • Powell never authorized or calculated payroll, withheld taxes, or paid them on the company’s behalf.

Because of all this, the Court said that Powell was not a “responsible person” at MAS, and the IRS should not have assessed the tax fund recovery penalty against him. The Court went on to say that even if he had been, there was no evidence that Powell willfully failed to file, since he had no knowledge or access to the company’s tax records. His later partnership with Pavlock in other businesses did not change that fact or subject him to penalties. The Court ordered the IRS to give back Powell’s $225, and dismissed the remaining $400,000 penalty assessment.

Attorney Joseph R. Viola is a tax attorney in Philadelphia, Pennsylvania with over 30 years experience. If you have questions about payroll taxes or trust fund recovery penalties, contact Joe Viola to schedule a consultation.

Categories: Tax / IRS Penalties