Section 2302 of the Coronavirus Aid, Relief, and Economic Security (CARES) Act, P.L. 116-136, allows employers to defer the payment of the employer share of Social Security or Railroad Retirement payroll taxes otherwise required to be deposited between March 27 and Dec. 31, 2020, and to pay the deferred taxes in two installments — the first half is due Dec. 31, 2021, and the remainder by Dec. 31, 2022.
Almost certainly, employers that are under financial strain due to the pandemic will have decided to defer these payments. They may also, or instead, defer the employee share of these taxes for Sept. 1 through Dec. 31, 2020, as authorized by an Aug. 8 presidential memorandum and Notice 2020-65. If elected, this deferral of the employee share of payroll taxes must be withheld and paid by employers ratably Jan. 1 through April 30, 2021.
While deferring these taxes may help an employer in the short term, when the deferred taxes come due, some businesses may not be able to pay them. If a business fails to pay the deferred taxes, the IRS may look to individuals who are responsible persons with respect to the business for the unpaid taxes.
Sec. 6672(a) provides that "[a]ny person required to collect, truthfully account for, and pay over any tax imposed by [the Internal Revenue Code] who willfully fails to collect such tax ... shall ... be liable to a penalty equal to the total amount of the tax evaded, or not collected." This is commonly referred to as the trust fund recovery penalty (TFRP), and a person required to collect, account, and pay over the taxes is referred to as a responsible person. Employment taxes are referred to as trust fund taxes because persons who are required to collect, account for, and/or pay them over hold the taxes in trust for the government.
A responsible person can be defined as one who has the duty to perform or the power to direct the collection, accounting for, and payment of the trust fund taxes. In Vinick, 205 F.3d 1 (1st Cir. 2000), the court listed seven factors that may be considered in ascertaining whether a person is responsible with respect to a company: The person (1) is an officer or member of the company's board of directors; (2) owns shares or possesses an entrepreneurial stake in the company; (3) is active in the management of the company's day-to-day affairs; (4) has the ability to hire and fire employees; (5) makes decisions regarding which, when, and in what order outstanding corporate debts, including taxes, are paid; (6) exercises control over bank accounts and disbursement records; and (7) has check-signing authority. No single factor determines responsibility; rather, the finding is based on the totality of the circumstances. The critical issue is whether the person had the actual authority or ability in the company to pay the taxes owed.
Generally, the possible responsible persons are officers of a corporation or the members of a limited liability company. Notably, CPAs who are involved in making financial decisions for an employer have been found to be responsible persons. Looking at the seven factors together, the pivotal question in determining whether an individual is a responsible person is whether and to what degree he or she had influence and control over the business's financial affairs. A factor considered in nearly every case is whether the individual had check-signing authority or exercised control over the business's bank accounts. While the authority to sign checks, standing alone, is generally insufficient to determine a person's liability, the IRS and the courts inquire into whether the alleged responsible person exercised authority over financial affairs.
Following the direction of a superior to not pay over the withheld taxes does not fully insulate a potentially responsible person from liability. Often, the IRS determines that more than one person is responsible. This places the burden on multiple persons to prove they are innocent, and each predictably points the finger at the other alleged responsible person or persons. The resulting conflict could be seen as giving the IRS a greater chance to collect the TFRP.
The Fifth Circuit in Hewitt, 377 F.2d 921 (5th Cir. 1967), held that willfulness in this context requires only a "voluntary, conscious, and intentional" act. For example, willfulness has been found where responsible persons knew of the outstanding taxes but, rather than pay them, intentionally used available funds to pay other creditors or business expenses. An evil intent or bad motive is not required. The courts have interpreted willfulness to include recklessly disregarding known risks that the trust fund taxes would not be paid. This test can be critically important, as most cases have competing facts, and the courts, without ever stating so directly, put great weight on whether the person at issue could have done a better job to protect the government's funds. In many circuits, reckless disregard includes the failure to investigate suspicions of unpaid taxes or to correct mismanagement after learning that withholding taxes have not been paid.
In earlier proceedings in Vinick (110 F.3d 168 (1st Cir. 1997)), the First Circuit recognized three factual scenarios that meet this standard:
- Reliance upon the statements of an individual in control of the finances when the circumstances show that the responsible person knew the individual to be unreliable;
- Failure to investigate or to correct mismanagement after having notice of nonpayment of withholding taxes; and
- Knowing that the business is in financial trouble and continuing to pay other creditors without making reasonable inquiry as to the status of the withholding taxes.
In Wright, 809 F.2d 425, 427 (7th Cir. 1987), the court held that a responsible person acts willfully under Sec. 6672 "if he (1) clearly ought to have known that (2) there was a grave risk that withholding taxes were not being paid and if (3) he was in a position to find out for certain very easily." While the tests in other circuits differ somewhat, it is fair to say that the courts do not allow someone to turn a blind eye to the nonpayment of payroll taxes.
The responsibility for the failure to pay trust fund taxes is not limited to the responsible persons who failed to pay the payroll taxes at the time they were due. If someone becomes a responsible person at a time when a delinquency for employment taxes for past quarters exists and uses unencumbered funds available at that time to pay other expenses, that individual may be found to be a responsible person with regard to the delinquent taxes and liable for the amount of the funds not used to pay them.
The individual bears the burden of proving by a preponderance of the evidence either that he or she is not a responsible person or that his or her failure to pay the taxes was not willful.
While the payroll tax deferrals under the CARES Act and presidential memorandum have in many cases relieved employers short of cash due to the effects of the COVID-19 pandemic from immediate liability for these taxes, a day of reckoning still looms. If a business cannot pay the employment taxes it owes, individuals associated with the business (including some who do not work directly for the business, such as the business's CPA) could find themselves liable for a TFRP.
Timothy Burke, CPA, J.D., LL.M., is in practice with Burke and Associates in Braintree, Mass., and is a member of the AICPA Tax Practice & Procedures Committee. To comment on this article or to suggest an idea for another article, contact Paul Bonner, a JofA senior editor, at Paul.Bonner@aicpa-cima.com or 919-402-4434.
