Any employer that withholds employment taxes from employees is required to remit them to the Internal Revenue Service on a timely basis when due. However, a struggling business often faces a dilemma. Should it
- "Borrow" the withheld amounts to keep the company afloat so it can continue to operate and pay off some or all of its debts?
- Comply literally with the language of the Internal Revenue Code even though the result might be that the company would immediately close and creditors, including the government, would not receive the entire amount owed them?
The U.S. Court of Appeals reviewed a case in which a company, Buffalow's, Inc., faced significant cash flow problems and couldn't pay its expenses. The company's controller had not paid federal employment taxes for several quarters. The only significant assets Buffalow's had were service contracts and customer lists, which would be of no value if the company shut its doors and liquidated. Henry Buffalow, the president and sole shareholder, decided that all creditors, including the government, would be better served by keeping the company running for a few months until a buyer for the assets could be found. Buffalow informed an IRS revenue officer of his plan. The officer asked Buffalow to keep her updated and to stay current with the payment of new employment taxes.
Buffalow's plan was partially successful. The company's assets were sold, and the government received more in unpaid employment taxes than it would have had the company liquidated when the problem was first discovered. However, the entire balance was not paid. For the unpaid balance, the IRS assessed Buffalow individually with a penalty under IRC section 6672 for failure to collect and pay over employment taxes withheld by Buffalow's, Inc. (the trust fund recovery penalty). The penalty was assessed against Buffalow individually because he was a "responsible person" who willfully caused the unpaid employment taxes not to be paid over.
Result: For the IRS. The Ninth Circuit Court of Appeals affirmed the lower court decision and rejected Buffalow's arguments that he should not be penalized because he had informed the IRS of his plan and his failure to pay over the tax was not "willful"and therefore he did not meet section 6672's criteria. The court said that as the IRS had not explicitly approved Buffalow's workout plan in writing, nothing prevented the government from assessing the penalty (even though the revenue officer may have been negligent in her implicit approval). The court explained that Buffalow's positive intentions did not affect his level of willfulness.
The court also acknowledged the favorable outcome Buffalow was trying to achieve. Even though his actions may have made economic sense for the government, the court cited established precedent, which allows little flexibility. When an individual willfully makes a payment to another creditor when the government is owed unpaid employment taxes, the trust fund recovery penalty is likely to be assessed.
CPAs should get written IRS approval before engaging in any workout arrangement that may compromise the government's interest. Any partial tax payments should be designated as applying to unpaid trust fund recovery taxes. If such a designation is not made, the IRS is free to allocate any tax payments to the taxpayer's non-trust-fund liabilities. (See revenue ruling 79-284, 1979-2 C. B. 83.)
Buffalow v. United States (109 F3d 570).
—Vinay Navani, CPA, technical manager,
AICPA tax information phone service.