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Last Updated on: 28th July 2023, 07:31 pm
Employers are required to withhold federal income and payroll taxes from employee wages. These taxes have to be paid to the IRS. Withheld payroll taxes are referred to as trust fund taxes, because the employer holds the money in a trust until a federal tax deposit is made for that amount. Sec. 6672(a) mentions that any person required to collect, truthfully account for, and pay over any tax imposed by the internal revenue code who fails to do so, will, in addition to to other penalties provided by the law, be liable to a penalty equal to the total amount of the tax not collected. The term any person, is critical because it allows the IRS to pierce the corporate veil, and proceed against anyone responsible for the corporation’s failure to pay trust fund taxes. It makes the person liable for the employer’s unpaid payroll taxes. As a result, the penalty can be imposed on the person, regardless of the business entity.
Both the person responsible, and the willful failure tests have to be met in order for the trust fund recovery penalty to apply. Once this penalty is assessed, the person held responsible has the burden of disproving both elements.
The Responsible Person Test
The IRS and the courts define a responsible person broadly. The main element in determining responsible person status is whether a person had a statutorily imposed duty to make the payments. Several factors indicate responsibility:
-The person has power to compel, or prohibit the allocation of funds
-Has authority to sign checks
-Has authority to make decisions to the disbursement of funds/payments of creditors
-Is an officer, or director of the corporation
-Has control over the company’s payroll
-Prepares and signs payroll tax returns
-Participates in day to day management
-Hires and fires employees
The list above isn’t exhaustive, but a good start to understand the fact the IRS looks at the person’s status, duty, and authority, to determine whether a person is responsible for paying over withholding taxes to the US. The IRS Policy Statement 5-14(Internal Revenue Manual §18.104.22.168.3), states that individuals who are non-owner employees performing ministerial acts without exercising independant judgement will not be held responsible.
Often, company officers don’t want to deal with accounting or tax matters. It’s not uncommon for a director to instruct an employee to take care of paying payroll taxes. If the employee fails, then officer should be worried. Delegation of authority doesn’t relieve a person of being accountable/responsible to collect/pay taxes to the IRS. The courts have ruled that the authority that permits controls, carries a duty to ensure that withholding of taxes is being properly done and paid to the government(Purcell, 1 F.3d 932 (9th Cir. 1993)).
The trust fund recovery penalty can be assessed against a corporate officer who fails to pay withheld taxes at the direction of a supervisor if the funds are available. The threat of being fired by a supervisor for paying taxes will not make the person less responsible for paying the taxes owed. Courts have ruled that officers aren’t allowed to do what allows them to keep employment over that of paying the government. A former president of a corporation can be considered responsible if he/she continues to retain authority to sign checks, and negotiate with the IRS, or owns stock in the corporation, or manages day to day business operations, or make decisions regarding the disbursement of money/payment to creditors.
What is willful failure
In terms of Sec. 6672, a failure to remit tax funds is considered willful, if it’s conscious, intentional, as opposed to accidental. Courts have decided that willfulness is true if a taxpayer knew of the nonpayment, or disregarded whether payments were being made or not.
How bad can it get
The IRS is very aggressive in assessing a trust fund penalty. Payroll taxes are the government’s money. The government believes those who don’t pay, are taking it’s money. The government will be relentless in its effort. With numerous employees, unpaid trust fund taxes pile up quickly. This penalty isn’t dischargeable in bankruptcy. Failing to pay trust fund taxes can lead to criminal charges. Under Sec. 7202, willful failure to pay or collect taxes is a felony punishable by up to a $10,000 fine or 5 years in prison. The IRS reservers criminal charges for the worst of cases, where a responsible person owned the business and diverted the money for personal use.
Anyone responsible under Sec. 6672, can be liable under Sec. 7207. This can apply to corporate officers, employees, and anyone responsible for collecting and paying taxes. The IRS generally targets owners who used funds for their own benefit. Courts have held Sec. 7202 creates three obligations – a person must collect, account for, and pay the taxes. If the person doesn’t do these 3 things, then he/she is in violation.
What does the responsibility for trust fund taxes mean for employers and employees?
In a world where employees rely on their employers for fair and accurate payment, there are unfortunately consequences that can arise due to noncompliance with federal income and payroll tax withholding rules. Employers are required to withhold these taxes and submit them to the IRS as trust fund taxes, as they are held in trust until paid. Failure to comply with this rule can lead to significant penalties under Section 6672(a), which can pierce through the corporate veil and hold any responsible person accountable for the unpaid taxes.
In order for an individual to be held responsible for the trust fund recovery penalty, they must meet both the responsible person test and the willful failure test. Once these penalties are assessed, it becomes the burden of the responsible person to disprove both elements. The IRS and legal courts define a responsible person rather broadly, considering factors such as an individual’s position within the company, their role in managing funds, and their overall authority. The significance of determining responsibility lies in understanding that the IRS evaluates an individual’s overall status, duty, and authority to assess accountability for payroll tax payment.
In many cases, higher-ups within a company may delegate the responsibility of paying payroll taxes to lower-level employees. However, it is still the responsibility of those higher-ups to ensure that taxes are collected and paid to the IRS. Case law has established that the duty to oversee tax management and payment remains with those in positions of power (Purcell, 1 F.3d 932 (9th Cir. 1993)).
Failure to comply with these trust fund tax requirements is considered willful if it is a conscious, intentional act rather than an accident. This is determined by whether the taxpayer knew about non-payment or showed disregard for whether payments were being made.
Employers should not underestimate the severity of the consequences brought about by failing to pay trust fund taxes. The IRS is renowned for its aggressive pursuit of these penalties, especially since payroll taxes constitute government funds. Unpaid taxes can quickly accumulate, and penalties are not dischargeable through bankruptcy. Furthermore, failure to pay trust fund taxes can also lead to criminal charges under Section 7202, potentially resulting in a fine of up to $10,000 and/or five years in prison.
Individuals found responsible under Section 6672 can also face further penalties under Section 7207, regardless of their position within the company. The IRS typically focuses on business owners who have used tax funds for their own personal gain. Section 7202 establishes an obligation for the responsible person(s) to collect, account for, and pay taxes; failure to meet these requirements violates federal law.
Act Promptly and Decisively to Avoid Complications
Unpaid trust fund taxes can lead to severe consequences for both companies and responsible individuals alike. Therefore, it is crucial to comply with all federal tax laws to avoid lengthy legal disputes and the possibility of penalizations, bankruptcies, and even criminal charges. Following the guidelines for withholding taxes and ensuring their proper payment to the IRS is not only a legal obligation but also a moral responsibility that safeguards the interests of employees and upholds the trust placed in employers.
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