Most employers must withhold Social Security, Medicare and federal income taxes from their employees’ wages. Businesses generally must collect and remit excise taxes from their customers. These withholdings are often referred to as “trust fund taxes” because the employers or businesses, as the case may be, hold them in trust for the United States until they pay them to the Treasury, pursuant to § 7501(a) of the Internal Revenue Code (IRC).1
If and when employers or businesses fail to pay their trust fund taxes on time, IRC § 6672 permits the government to impose the “Trust Fund Recovery Penalty” (“TFRP”) on persons (usually individuals) other than those employers or businesses. The amount of the TFRP is 100% of the delinquent trust fund taxes. It is distinct from and in addition to the original tax liability; and it is a personal liability, not limited by any corporate liability of the original employer or business.
In determining whether the § 6672 TFRP applies to a person other than the relevant employer or business, courts focus on:
“Responsible person” is the shorthand phrase for a “person required to collect, truthfully account for, and pay over any tax imposed by this title” as described in § 6672. In the Supreme Court decision of Slodov v. United States, it was clarified that a person does not have to be in a position to perform all three of these duties with respect to the tax dollars in question to be a responsible person; it is sufficient that they are required to collect third-party taxes.1 This person can be an officer of a corporation, a member of a partnership, a corporate director, a shareholder, or any other person, including another corporation. The key consideration is whether they have significant influence and control over the financial affairs of the business or employer who was supposed to collect the taxes in the first place – especially the disbursement of funds and the priority of payments to creditors.2 There can be more than one responsible person. The statute does not require the government, in seeking to satisfy the TFRP, to limit its target to the highest-ranking responsible person or, conversely, to pursue every responsible person.3
The responsible person must have also acted “willfully” for the TFRP to apply. Absent a definition in the Code, the courts have defined willfulness in the context of § 6672 as a “voluntary, conscious and intentional decision to prefer other creditors over the Government.”4 No evil or fraudulent motive is required. If the responsible person knew, or ought to have known, that trust fund taxes were owed, and then deliberately chose to pay others first, or recklessly disregarded an obvious risk that the trust fund taxes would not be paid, willfulness exists.5 In the situation where funds are not available to cover both wages and withholding taxes, a responsible person has a duty to prorate the available funds between the United States and the employees so that the taxes are fully paid on the amount of wages paid. Doing otherwise would constitute preferring employees to the government and would be considered willful.6
Reasonable Cause Defense
The circuit courts do not agree as to whether the defense of “reasonable cause” is available in the TFRP context. Although other penalty provisions in the Internal Revenue Code specifically permit this defense, § 6672 does not. Some circuits have taken this to mean it is simply not available.7
Factors Going to Responsibility: Status, Duties and Authority
The test for determining a “responsible person” is one of substance and not form. In Godfrey v. United States,8 for example, Mr. Godfrey’s status as Chairman of the Board provided him with a great deal of broad, top-level formal authority. Everyone looked to him for ultimate decisions on financial, personnel and management decisions. However, his actual duties did not include any participation in the business’ day-to-day financial operations and decisions. He did not sign, or have authority to sign, checks; he did not control payroll or decide which creditors would be paid; and he did not own a significant number of voting shares. He was held not to be a responsible person as he could not be seen, in all the circumstances, as a person who had any control over the collection, accounting for, and payment over of trust fund taxes.
On the other hand, in Gephart v. United States,9 Mr. Gephart was found to be a “responsible person” even though he was neither a director nor an officer and did not own any shares. His title was General Manager and his authority was subordinate to that of the company’s executive officers. However, Mr. Gephart performed many day-to-day administrative, accounting and operating functions of the business involving financial knowledge, judgment and discretion. This included writing to customers and suppliers, participating in financial meetings, dealing with creditors or debtors, determining the priority of bills to pay and having general responsibility over payroll.
Factors Going to Willfulness: Knowledge, Reckless Disregard of Known Risk, and Preference of Other Creditors and Payment Attempts
For a person to “consciously” choose to prefer creditors other than the tax authorities, they must have had knowledge, actual or constructive, that the trust fund taxes were owing in the first place. As for the choice being “intentional,” a reckless disregard of an obvious risk that the trust fund taxes would not be paid can show intention to prefer creditors just as much as a deliberate action.
In Jenkins v. United States,10 the court found that, despite Mr. Jenkins’ claim that he only knew about the tax delinquencies relatively recently, the company’s past tax problems and installment agreement to pay back taxes, along with the fact that the company’s President had been unreliable in this regard, pointed to a conclusion that he knew about the risk of non-payment for quite some time previously, but ignored the situation. It was no defense that he trusted the company’s President – as soon as he had this knowledge, he ought to have been monitoring the situation to make sure the payments were being made and taking corrective action if they were not. Finally, apart from the reckless disregard of the risk of non-payment, even when Mr. Jenkins admitted he fully realized the tax problem, he clearly preferred other creditors by writing checks to others with unencumbered funds, instead of immediately using all unencumbered funds available to pay the trust fund taxes owing.
The Limited Availability of “Reasonable Cause”
The circuit courts that have held that “reasonable cause” can negate willfulness have also held that the application of this defense is extremely limited. While other tax penalties might be avoided with reasons such as the illness of the taxpayer, an inability to obtain records, or undue hardship, such excuses they have little to no significance in the TFRP context. Reliance on a third-party professional’s tax advice, however, might constitute reasonable cause,11 as might circumstances beyond the taxpayer’s control that frustrated a taxpayer’s reasonable efforts to protect the trust funds.12
The following list is a potential guide to considering liability for the TFRP:
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