Embezzlement No Excuse

The Third Circuit recently affirmed a district court’s opinion holding a corporation liable for payroll taxes embezzled by its payroll agent.

Pediatric Affiliates PA of New Jersey (Pediatric) hired PAL Data Processing Inc. (PAL) to handle its payroll needs. PAL’s founder, Menachem Hirsch, would routinely send Pediatric a tax form that accurately calculated Pediatric’s payroll taxes, and Pediatric would remit the funds to PAL. However, Hirsch would send only part of the payments to the IRS, keeping the rest. Hirsch engaged in the same procedures with more than 50 clients, embezzling more than $2 million. Pediatric learned of Hirsch’s misappropriation in 2002, when it received IRS notification that it underpaid its payroll taxes for 1999 and 2000. Hirsch subsequently pleaded guilty to wire fraud and tax evasion and received monetary penalties and 37 months in prison. Pediatric also brought suit against PAL and Hirsch for fraud and won a $1.2 million judgment.

Meanwhile, the IRS initiated a levy against Pediatric’s assets for the deficiency. Pediatric claimed it was not liable for the deficiency or interest because it had paid the correct amount to PAL. A federal district court in New Jersey held for the IRS, and Pediatric appealed.

The Third Circuit cited the Supreme Court case of U.S. v. Boyle for the well-established principle that reliance on a third party does not excuse a taxpayer of its obligations. In addition, a taxpayer signs Form 8655, Reporting Agent Authorization, which states that the agency arrangement “does not relieve [it], as the taxpayer, of the responsibility to ensure that all tax returns are filed and that all deposits and payments are made.”

Pediatric argued that under the doctrine of judicial estoppel the IRS could not both charge Hirsch with tax evasion and enforce payment against Pediatric. Also, Pediatric argued that a holding for the IRS would force Pediatric to pay the taxes twice. The Third Circuit stated that judicial estoppel was not applicable in such circumstances and noted that although Pediatric may have been obligated to pay the taxes twice, the IRS would receive them only once. Furthermore, the court said Pediatric had received an alternate remedy in the lawsuit judgment.

Finally, Pediatric argued that the doctrine of equitable estoppel prevented the IRS’s collection of the deficiency. The argument was based on an oral representation by an IRS appeals officer during administrative proceedings that Pediatric should not be held responsible for money stolen by Hirsch. Finding no written evidence of these statements or detrimental reliance on the statements by Pediatric, the court held the doctrine to be inapplicable.

Pediatric Affiliates v. U.S. , 99 AFTR2d 2007-2240

Prepared by Laura Lee Mannino , CPA, LL.M., assistant professor of accounting and taxation, St. John’s University, Jamaica, N.Y.