In a 2–1 decision, the U.S. Court of Appeals for the Fourth Circuit upheld the decision of the U.S. District Court for the Middle District of North Carolina that a shareholder/officer of a corporation was personally liable for the corporation’s unpaid withholding and payroll taxes. The majority of the appellate court agreed with the lower court that the taxpayer was a responsible person of the corporation and willfully failed to remit four quarters of payroll taxes.
IRC § 6672(a) imposes a penalty on any responsible person who willfully evades or fails to collect, pay or account for payroll taxes. The amount of the penalty is the tax evaded or not collected, accounted for or paid to the government. To be liable for the tax, a person must have possessed actual and significant authority over an enterprise’s finances and decision making, including paying the taxes (a responsible person) and either knew the payments were not being made or recklessly disregarded whether they had been made. Factors that can indicate such authority include that the person: “(1) served as an officer of the company or as a member of its board of directors; (2) controlled the company’s payroll; (3) determined which creditors to pay and when to pay them; (4) participated in the day-to-day management of the corporation; (5) possessed the power to write checks; and (6) had the ability to hire and fire employees” (quoting Plett v. U.S., 185 F.3d 216 (4th Cir., 1999)). A company may have multiple responsible persons.
In 1994, Charles Erwin, an owner/operator of restaurants for 25 years, and three other businessmen formed GC Affordable Dining Inc. (GCAD) to own and operate five restaurants as part of the Golden Corral chain. After a couple of profitable years, the corporation began losing money, prompting the owners in the first half of 1998 to replace GCAD’s manager and to hire a new accountant to handle accounting and payroll and the related taxes. In December 1998, Erwin and the other owners learned the 1998 third-quarter payroll taxes had not been paid on time. The owners made a cash infusion, and Erwin instructed the accountant that payroll taxes must always be paid when due. However, the taxes were not fully paid in the last quarter of 1998 or the first three quarters of 1999. In December 1999, the owners invested additional capital, but again some of the taxes remained unpaid. The owners fired the accountant in February 2000, and Erwin assumed full control of all accounting functions.
After GCAD went out of business in 2001, the IRS made an assessment against Erwin for GCAD’s unpaid payroll taxes, which he partially paid. He filed suit against the government in the U.S. District Court for the Middle District of North Carolina to recover the amounts he had paid, while the government filed a counterclaim of $264,579 against Erwin. After the district court held that Erwin was liable for the taxes, he appealed the decision to the Fourth Circuit.
Using the Plett factors, the court held that Erwin was a responsible person for purposes of section 6672(a). According to the court, Erwin was a responsible person because (1) he was GCAD’s secretary, treasurer, vice president and one of its directors from the time of its inception; (2) he exercised significant supervisory authority over the management team directly responsible for payroll issues and then took total control of all financial operations shortly after learning of the payroll tax issue; (3) he and another partner determined when to pay certain creditors during 1998 and 1999; (4) he participated in day-to-day operating decisions by choosing restaurant sites, negotiating leases and meeting with managers, although he did not have the most active day-to-day management role; (5) he was involved in hiring and firing the accountants and upper-level managers; and (6) despite not having check writing authority during the period in question, he could have had that authority if he chose.
The court further held that Erwin had willfully failed to remit the payroll taxes. It stated that even if he did not have actual knowledge of the unpaid taxes before August 1999, once he did know they had not been paid, he acted with reckless disregard when he did not immediately pay them.
In a dissenting opinion, Senior Circuit Judge Clyde H. Hamilton wrote that the Plett factors did not support the finding that Erwin was a responsible person under section 6672(a). He stated that Erwin’s decision to control the payroll functions after the third quarter of 1999, thus becoming a responsible person, did not imply he was a responsible person during the four preceding quarters. Also, Erwin’s participation in hiring an accountant differed from controlling the payroll function, Hamilton said. He further stated that, during the four quarters in question, Erwin had little input concerning which creditors to pay.
Hamilton also noted Erwin was not a signatory on any of the bank accounts during the four quarters. Finally, Erwin was involved in the hiring and firing of upper-level management, but there was no evidence that he participated in day-to-day personnel decisions, Hamilton said.
Charles B. Erwin v. U.S., docket no. 08-1564
By Charles J. Reichert, CPA, professor of accounting, University of Wisconsin–Superior.