Make Sure You Pay Over Payroll Taxes on Time

During times when cash flow is tight, businesses and not-for-profits might be tempted to use withheld payroll taxes to foot some of their bills. Big mistake! Under federal law, “responsible” individuals can be held personally liable for the taxes – regardless of whether the company’s legal structure shields them personally from other obligations. You might be surprised to find out how many people the IRS can find “responsible” in one organization. Here are the rules, along with some recent court cases in which business owners and executives were penalized for failing to remit payroll taxes.

DON’T LET A CASH FLOW SHORTFALL MAKE YOU PERSONALLY LIABLE

Uncle Sam wants you to deposit federal payroll taxes on time. That means your organization must fork over amounts withheld for income tax, FICA and FUTA during the course of the year.

Generally, the deposits are made on a monthly or semi-weekly basis. But when cash is tight, business owners and executives can be tempted to borrow from withheld payroll taxes in order to keep operating. In other words, they use the money as a short-term loan to pay off other creditors until cash flow improves. This is never a good idea.

If you fail to meet payroll tax obligations on behalf of your organization, you could be held personally liable for the full amount of the unpaid taxes under Section 6672 of the Internal Revenue Code.

The fine is sometimes called the “100 Percent Penalty,” although the IRS prefers the less ominous “Trust Fund Recovery Penalty.” But the result is the same: An officer, business owner or other responsible employee can personally be assessed as much as 100 percent of the amount. And that doesn’t include interest.

Corporate Entity Offers No Protection

Don’t assume your corporate veil will shield you or other officers. Unlike other financial obligations, payroll taxes are one area where you cannot escape personal liability. Even if a business files for bankruptcy, the debt is not dischargeable.

The IRS will try to collect from you personally if you’re the person responsible for payroll tax deposits and the transgression was due to a “willful failure.” In some cases, tax evasion can even result in a criminal sentence.

You might be surprised to know this severe tax exposure isn’t limited to the employees handling the organization’s books. An officer may be held responsible if he or she supervises payment of payroll taxes or has authority over payment. The courts have generally taken a broad approach to designating “responsible persons.”

What’s more, the IRS is quick to point fingers and it is not unusual for several people in one company to be found “jointly or severally” liable for the Section 6672 penalty.

Don’t expect the courts to be lenient. To illustrate, here are three recent cases where the IRS assessed the penalty for a willful failure:

Case #1: An individual who became the chief executive officer was held personally liable for the unpaid payroll tax obligations of a wholly owned subsidiary. As the CEO, the individual had authority to control the financial affairs of the subsidiary. He wasn’t relieved of this responsibility even though he took control after the holding company stopped paying the payroll taxes. Despite full knowledge of the unpaid tax obligations, he arranged for the subsidiary’s funds to be paid to other creditors.

However, the District Court in Alaska said the individual was not responsible for unpaid tax obligations during the time he was a member of the board of directors and had no official role in the subsidiary’s operations or any control over it (Haslett, DC-AK, 3:06-cv-00150-JWS, 2/9/09).

Case #2: After the president of a commercial printing business stepped down for medical reasons, her husband took over the reins of the operation. He continued to pay the company’s creditors and handle payroll matters. But the husband didn’t file payroll tax returns with the IRS for the year in question, even though he was fully aware of this obligation, according to court documents. The District Court in Arkansas imposed the penalty for failing to pay payroll taxes in a timely manner (Benton Workshop, Inc., DC-AR, 4:08CV00339-WRW, 8/21/09).

Case #3: The CEO of a restaurant franchise found out that the company’s in-house accountants had not deposited payroll taxes with the IRS. Nevertheless, he did not fire the accountants until six months had passed. In the meantime, he continued to use company funds to pay off other debts. The Fourth Circuit Court of Appeals said that the CEO should have paid the IRS first. Accordingly, he was held personally liable for the unpaid amount (Erwin, No. 08-1564, 4th Circuit Court of Appeals, 1/13/10).

Obviously, with so much at stake, it makes sense to take precautions. Here are some steps to consider:

Designate one employee to pay the taxes and another to verify payment has been made. In some cases, fraudulent schemes have been implemented to steal from payroll tax accounts.

Assign back-ups to both employees in case of sick days, vacations or other absences.

Require updates on tax payments. Personally check to ensure payment has been made.

Use an experienced professional or professional organization to handle payroll matters.

Don’t leave payroll tax obligations to chance. It is better to be overly vigilant than to face an unpleasant tax surprise if the IRS comes calling.

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WHAT THE TAX CODE SAYS

The relevant section of Section 6672 reads:

“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.”

BUSINESS WISDOM FOR TODAY’S ECONOMY

The IRS Can Go After Multiple People in One Company

The IRS can go after and collect unpaid payroll taxes from as many people as it finds liable. In other words, even if one person has already been assessed the fine, the tax agency can collect it again from another responsible person.

This was illustrated in one court case in which a CEO and a CFO were both penalized.

In the case, a Pennsylvania trucking company failed to pay some of its federal employment tax obligations. The CEO and the CFO tried “to escape liability by arguing strenuously that the other was the sole responsible party,” according to U.S. District Court documents.

The court ruled that both officers were liable, noting that “while a responsible person must have significant control over the corporation’s finances, exclusive control is not necessary.” (Horovitz, U.S. District Court, WD Penn. 2008)

In determining whether an individual is responsible, the court considered:

The corporate bylaws.

The ability to sign checks on the company’s bank account.

The signature on the employer’s federal quarterly tax return.

Payment of other creditors in lieu of the federal government.

Identity of officers, directors, and principal stockholders in the firm.

The ability to hire and discharge employees.

The identity of individuals in charge of the firm’s financial affairs.