Court’s Ruling Holding Corporate Officer Responsible for Trust Fund Recovery Penalty Illustrates Risk of Personal Liability for Unpaid Employment Taxes

A district court in the Northern District of California has held that the officer of a now-defunct corporation is personally responsible for the Trust Fund Recovery Penalty based upon the company’s failure to collect, account for, and pay over federal withholding taxes. See United States v. Guerin, 113 AFTR 2d 2014 (N.D. Cal. April 28, 2014). In 1994, Fitz William Guerin, the defendant, purchased an existing software development and advertising firm that he renamed Orbit Network, Inc. Mr. Guerin served as the company’s president and chief executive officer, and also was a minority shareholder. He was also an authorized signer on the company’s bank accounts and checks, and he also signed the company’s quarterly employment tax returns (Forms 941).

Beginning on June 1, 1998, Mr. Guerin became aware that Orbit was not making timely payments of federal employment taxes. Despite that knowledge, Mr. Guerin thereafter authorized payments to company creditors other than the U.S. Treasury, and he personally signed checks payable to creditors other than the government during that time period.

Pursuant to IRC § 6672, the IRS thereafter assessed liabilities against Mr. Guerin personally for the company’s unpaid employment taxes for numerous quarters between 1996 and 1999. The total amount of the assessments exceeded $600,000.

Section 6672(a) provides, in relevant part, that:

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 … be liable to a penalty equal to the total amount of the tax evaded, or not collected, or not accounted for and paid over.

Under § 6672(a), an individual may be held liable for unpaid withholding taxes if (1) he or she was a “responsible person” for collection and payment of the employer’s taxes; and (2) he or she “willfully” failed to pay the tax. United States v. Jones, 33 F.3d 1137, 1139 (9th Cir. 1999). For purposes of § 6672, a “person” includes “an officer or employee of a corporation … who … is under a duty to perform the act in respect of which the violation occurs.” 26 U.S.C. § 6671(b).

Responsible Officer Analysis

The Court first addressed the question of whether Mr. Guerin was a “responsible officer.” The Court observed that district courts employ a number of factors to determine whether a person is a “responsible person” for purposes of imposing liability. Although no single factor is dispositive in evaluating whether an individual is a “responsible person” within the meaning of § 6672(a), “the most critical factor is whether a person had significant control over the enterprise’s finances.” United States v. Chapman, 7 Fed. App’x. 804, 807 (9th Cir. 2001) (citations omitted). An individual is more likely to be found responsible if he or she: (1) holds corporate office; (2) has check-signing authority; (3) can hire and fire employees; (4) manages the day-to-day operations of the business; (5) prepares payroll tax returns; (6) signs financing contracts; and (7) determines financial policy. Jones, 33 F.3d at 1140–41; Jordan v. United States, 359 F. App’x 881, 882 (9th Cir. 2002). Importantly, more than one person may be held liable under § 6672(a); an individual need not be “the most responsible.” Chapman, 7 Fed. App’x. at 806–07.

Applying these factors, the Court easily concluded that Mr. Guerin was a responsible officer based upon the following facts:

  • Defendant was a founder of the company and served as President and Chief Executive Officer until October 5, 1999, when he resigned.
  • Defendant was also a minority shareholder and a member of the senior management team that ran the company.
  • Defendant supervised senior management, but never had a supervisor himself.
  • Defendant could hire and fire employees, and was solely responsible for hiring and terminating members of Orbit’s senior management.
  • Defendant was an authorized signer on Orbit’s bank accounts, there were no restrictions on his ability to sign checks on Orbit’s behalf, and he signed checks on Orbit’s behalf. While others were also authorized signers on Orbit’s bank accounts, Defendant alone was authorized to issue checks without a co-signer.
  • Defendant managed the day-to-day operations of the business, such as “[d]irect[ing] an executive management staff;” “managing employees;” “signing or countersigning corporate checks;” “making or authorizing bank depots;” and “dealing with major customers.”
  • Defendant had the authority to, and did, sign quarterly employment tax returns (Forms 941) on behalf of Orbit. Among others, Defendant was responsible for collecting, accounting for, and paying over federal withholding taxes for Orbit.
  • Defendant had the authority to sign contracts and agreements binding Orbit, including a Binding Letter of Intent which contemplated a merger of two companies.
  • Defendant represented Orbit in meetings with financial backers and potential investors.
  • Defendant, among others, had the authority to, and did, determine to whom corporate disbursements would be made on behalf of Orbit, and to direct that such disbursements be made.
  • Defendant testified that he was responsible for making decisions about the strategic direction of Orbit; and that he had the “final say” with respect to acquisitions.

Willfulness

The Court next turned to the question of whether Mr. Guerin willfully failed to collect, account for, or remit payroll taxes. A responsible person may not be held personally liable under section 6672(a) unless his or her failure to collect, account for, or remit withholding taxes was willful. Winter v. United States, 196 F.3d 339, 345 (2d Cir. 1999). Willfulness involves a “voluntary, conscious and intentional act to prefer other creditors over the United States.” Buffalow v. United States, 109 F.3d 570, 573 (9th Cir. 1997). Thus, “[i]f a responsible person knows that withholding taxes are delinquent, and uses corporate funds to pay other expenses, … our precedents require that the failure to pay withholding taxes be deemed “willful.””Phillips v. I.R.S., 73 F.3d 939, 942 (9th Cir. 1996).

The Court also easily found that the defendant acted with the requisite level of willfulness, based upon Mr. Guerin’s admission that he was aware that federal withholding taxes were not being paid in 1998, but nevertheless continued to pay other creditors. The Court found that “Defendant’s deliberate decision to use corporate revenues received after he first became aware of the delinquency to pay other creditors, including himself, rather than to diminish Orbit’s tax debt falls within the literal terms of the Ninth Circuit’s definition of willfulness. Klotz v. United States, 602 F.2d 920, 923 [44 AFTR 2d 79-5709] (9th Cir. 1979) (“Willfulness” is defined as a “voluntary, conscious and intentional act to prefer other creditors over the United States.”).”

Joint and Several Liability

Finally, the Court addressed an argument advanced by Mr. Guerin that the IRS should have sought payment of the company’s unpaid employment taxes before pursuing him. Under IRC § 6672, liability may extend to more than one corporate officer, not just the most responsible. In particular, the responsible officer penalty is distinct from and in addition to the employer’s liability for these taxes.  The Court rejected this argument, finding that even if there were entities or individuals other than the defendant through whom the IRS could have collected Orbit’s unpaid trust fund taxes, Mr. Guerin could not escape liability on those grounds because the government is not required to pursue collection against every responsible person, or against the corporation itself, before attempting to collect from a responsible person under § 6672.

Analysis

The Court’s decision in United States v. Guerin is illustrative of the personal risks that corporate officers face when companies fail to timely deposit employment taxes. Responsible officers can face personal liability for their company’s unpaid employment taxes if the failure to pay over the taxes is determined to be willful. As the Guerin decision demonstrates, willfulness is not a difficult legal standard for the government to satisfy, especially when it is undisputed that the corporate officer in question was aware of the unpaid employment taxes and authorized payments to other creditors. In small businesses, corporate officers will almost always be aware of the fact that employment taxes are not being paid, and that company funds are being used to pay other creditors.

In addition to being held personally responsible for unpaid corporate employment taxes, corporate officers may also face criminal liability for failing to pay withholding taxes. The IRS describes the fraudulent practice of withholding taxes from employees but intentionally failing to pay over the taxes as “pyramiding”:

“Pyramiding” of employment taxes is a fraudulent practice where a business withholds taxes from its employees but intentionally fails to remit them to the IRS. Businesses involved in pyramiding frequently file for bankruptcy to discharge the liabilities accrued and then start a new business under a different name and begin a new scheme.

The IRS Criminal Investigation Division, in its most recent annual report, states that one of its top enforcement priorities in the employment tax area is combating the illegal practice of withholding employment taxes and failing to pay over those taxes to the U.S. Treasury. Two recent criminal cases illustrate the efforts of the IRS and the Justice Department in the employment tax fraud area.

On April 30, 2014, the Justice Department announced that an attorney in Oklahoma had pleaded guilty to willfully failing to pay employment taxes in connection with his law practice. See United States v. Larry Douglas Friesen (W.D. Oklahoma) (DOJ press release here). In that case, the defendant failed to pay over to the IRS the federal income and FICA taxes due and owing during three tax quarters in the 2007 calendar year in the amount of approximately $320,000.

In another case, the Justice Department announced on April 11, 2014, that a physician in Indiana had been sentenced to a prison sentence of one year and a day for failing to pay employment taxes in connection with his medical practice. See United States v. Ronald Eugene Jamerson (N.D. Indiana) (press release here). According to court pleadings, Jamerson deducted and collected from his employees’ paychecks federal income taxes and employment taxes in the amount of $63,929 over 11 tax quarters between 2006 and 2008, but failed to file the employment tax returns and pay over the related employment taxes. The defendant was ordered to pay restitution to the IRS in the amount of $541,083 for unpaid individual income taxes and employment taxes, which represented the total tax loss owed for all tax periods from 2003 through 2008, according to the plea agreement.

 

 

Fourth Circuit Affirms Responsible Officer Penalty Against Wife for Husband’s Unpaid Employment Taxes

On November 5, 2013, the Fourth Circuit upheld the assessment of a responsible officer penalty, pursuant to 26 U.S.C. § 6672, in the amount of $304,355.90 against a wife due to her husband’s failure to pay employment taxes to the Internal Revenue Service.  See Johnson v. United States, No. 12-1739 (Nov. 5, 2013) (opinion available here).

The Internal Revenue Code requires employers to withhold federal social security and income taxes from the wages of their employees.  See 26 U.S.C. §§ 3102(a), 3402(a). Because the employer holds these taxes as “special fund[s] in trust for the United States,” 26 U.S.C. § 7501(a), the withheld amounts are commonly referred to as “trust fund taxes,” Slodov v. United States, 436 U.S. 238, 243 (1978) (internal quotation marks omitted).  The Code “assure[s] compliance by the employer with its obligation . . . to pay” trust fund taxes by imposing personal liability on officers or agents of the employer responsible for “the employer’s decisions regarding withholding and payment” of the taxes.  Id. at 247 (interpreting 26 U.S.C. § 6672).  To that end, § 6672(a) of the Code provides that “[a]ny person required to collect, truthfully account for, and pay over any tax . . . who willfully fails” to do so shall be personally liable for “a penalty equal to the amount of the tax evaded, or not . . . paid over.”  26 U.S.C. § 6672(a).  Personal liability for a corporation’s unpaid trust fund taxes extends to any person who (1) is “responsible” for collection and payment of those taxes; and (2) “willfully fail[s]” to see that the taxes are paid.  Plett v. United States, 185 F.3d 216, 218 (4th Cir. 1999); O’Connor v. United States, 956 F.2d 48, 50 (4th Cir. 1992).

In the Johnson case, in 1969, Mr. Johnson (the husband) formed a non-profit corporation, Koba Institute, Inc., to perform various government contracts in conjunction with Koba Associates, Inc., a for-profit corporation that he owned and managed.  When Koba Associates failed to pay its payroll taxes in the mid-1990s, the IRS assessed trust fund recovery penalties against Mr. Johnson pursuant to 26 U.S.C. § 6672.  The outstanding payroll taxes, accompanied by the lien subsequently imposed on Mr. Johnson for the § 6672 trust fund recovery penalties, ultimately led Mr. Johnson to close Koba Associates. The presence of the lien limited Mr. Johnson’s ability to obtain credit for Koba Institute.

Mr. Johnson thereafter approached Mrs. Johnson (his wife) about restructuring Koba Institute so as to facilitate a continuation of their business.  In 1998, Koba Institute converted to a for-profit corporation under Maryland law, with Mrs. Johnson as its sole shareholder.  Because Mrs. Johnson was not encumbered by a lien like Mr. Johnson, her status as the corporation’s owner enabled Koba Institute to enter into leases and other contracts, as well as obtain lines of credit.

As the sole shareholder of Koba Institute, Mrs. Johnson elected herself as chair of the corporation’s board of directors in 2001.  According to the Johnsons, because they had agreed that Mrs. Johnson would be the primary caregiver of the couple’s children, Mrs. Johnson “delegated” and “entrusted” her authority in the corporation to Mr. Johnson, and thereafter elected Mr. Johnson president of Koba Institute on February 20, 2001, notwithstanding the contrary bylaw requirement.  Mrs. Johnson, in turn, served as the corporation’s vice president. 

Koba Institute’s board of directors — comprised of the Johnsons and an unrelated corporate secretary — unanimously approved a resolution authorizing Mr. Johnson (as president) and Mrs. Johnson (as vice president) to sign corporate checks and conduct financial transactions on behalf of the organization.  In addition, Koba Institute’s payroll account provided that Mrs. Johnson had the power to “sign singularly” on that account.

Having “delegated” her authority to Mr. Johnson, Mrs. Johnson’s actual involvement at Koba Institute was limited during the 2001 through 2004 period.  She did maintain an office at Koba Institute and received an annual salary ranging from approximately $100,000 to $193,000, as well as a corporate car and cell phone.  In addition, the rent for Mrs. Johnson’s residence, shared with Mr. Johnson, was provided by Koba Institute. 

In the 2001 to 2004 period, Mrs. Johnson only came to work once per month.  When she did so, she would approve any board resolutions, such as ratification of Mr. Johnson’s acts as president, or perform tasks in the human resources department.  Mr. Johnson made the ultimate decisions regarding the hiring and firing of employees.  Indeed, because Mr. Johnson oversaw the corporation’s day-to-day operations, other employees viewed him as “the one who decides everything” and went to Mr. Johnson – rather than Mrs. Johnson – with any questions that arose in the business, including financial matters such as the payment of payroll taxes.

When Mr. Johnson was out of the office, he left explicit instructions for Mrs. Johnson to follow on Koba Institute business, including which checks to sign in his absence.  Because of her limited involvement with the corporation’s daily operations, however, Mrs. Johnson was unaware of “the background or the context” for these checks and did not feel comfortable signing any checks that Mr. Johnson had not authorized.  Accordingly, from 2001 through 2004, she never attempted to write checks that Mr. Johnson had not already approved.

Near the end of 2004, Mrs. Johnson received a notice from the IRS that Koba Institute had not paid its payroll taxes for several quarters from 2001 through 2004.  Prior to that time, Mrs. Johnson was unaware that the payroll taxes were unpaid.  Upon receipt of the notice, she had “a serious talk” with Mr. Johnson and “told him” that the situation was “unacceptable” and that Koba Institute had “to take steps to make sure that it [did not] happen again.”  Mrs. Johnson then fired the finance director, who had been tasked with making payroll tax payments, and “directed Mr. Johnson to personally handle all future tax payments as of January 2005.”  She “required” Mr. Johnson to provide her with “visual proof” of all withholding tax payments that Koba Institute subsequently made.  Additionally, at least with regard to the payroll account, Mrs. Johnson no longer followed the prior procedure for check authorization; that is, she no longer required instruction from Mr. Johnson before writing checks herself from the payroll account for payment of the taxes.

Due to Mrs. Johnson’s “revamped oversight of tax payments,” Koba Institute began remitting its post-2004 payroll taxes to the IRS in full and, generally, on time.  The corporation did not, however, pay the outstanding delinquent payroll taxes for the 2001 through 2004 delinquent periods although it continued to pay its other business debts, such as employee wages and Mrs. Johnson’s compensation.  Subsequently, the IRS assessed trust fund recovery penalties against Mr. and Mrs. Johnson individually, pursuant to 26 U.S.C. § 6672.

Mrs. Johnson later paid $351.00 toward her assessed penalty, and filed a refund suit in district court, asserting that the § 6672 assessment against her was erroneous.

After the district court upheld the responsible officer penalty assessments, the Johnsons filed an appeal to the Fourth Circuit.  The court of appeals first addressed whether Mrs. Johnson was a “person responsible” for the payment of Koba Institute’s withholding taxes.  The Code defines a “responsible person” as one “required to collect, truthfully account for, and pay over any tax.”  26 U.S.C. § 6672(a).  The Supreme Court has interpreted this statutory language to apply to all “persons responsible for collection of third-party taxes and not . . . [only] to those persons in a position to perform all three of the enumerated duties.” Slodov, 436 U.S. at 250.  Thus, the Code deems anyone required to “collect” or “account for” or “remit” taxes a “responsible person” for purposes of § 6672.

The Fourth Circuit found the following facts relevant to the determination of whether Mrs. Johnson was responsible for the payment of withholding taxes:

Mrs. Johnson had been the corporation’s sole shareholder since 1998 and consequently had the effective power to change the officers and directors as she chose and thereby direct the business of the corporation.  Separately as both vice president and chair of the board of directors since early 2001, Mrs. Johnson enjoyed considerable actual authority at Koba Institute.

The corporation’s bylaws, board resolutions, and banking documents demonstrate that Mrs. Johnson was a “responsible person,” as it is clear that she had effective control of the corporation, including its finances. . . . The foregoing corporate documents indicate that Mrs. Johnson, while serving as chair of the board, would also serve as president of the corporation, a role that included authority to manage Koba Institute’s daily affairs and to execute checks and other legal documents on its behalf. Although Mrs. Johnson “delegated” and “entrusted” this authority to Mr. Johnson prior to 2005, . . . remaining only minimally involved in the corporation’s affairs as board chair and vice president, delegation of such authority does not relieve a taxpayer of responsibility under § 6672. . . . A taxpayer may be a “responsible person” if she “had the authority required to exercise significant control over the corporation’s financial affairs, regardless of whether [s]he exercised such control in fact.” . . .  Thus, despite delegating her authority to Mr. Johnson and permitting him to run the corporation’s daily affairs, Mrs. Johnson remained a “responsible person” because she had effective control of the corporation and the effective power to direct the corporation’s business choices, including the withholding and payment of trust fund taxes.

Although Mrs. Johnson maintains that any authority she held was merely technical in nature, the undisputed evidence establishes that she possessed both legal and actual authority over Koba Institute.  . . . Mrs. Johnson’s voluntary minimal involvement in daily corporate affairs before 2005, however, and assertions that Mr. Johnson exercised all daily operating authority fail to create a genuine dispute of material fact regarding limitations on her effective power as to the trust fund taxes.  Any deferral by Mrs. Johnson in the exercise of her authority never altered the fact that she possessed “effective power” over Koba Institute at all times. . . .  Indeed, Mrs. Johnson’s actions immediately after learning of the tax delinquencies in December 2004 – a period that “cast[s] light” on her responsibility from 2001 through 2004 – demonstrate that her actual authority was co-extensive with the legal authority she possessed. . . . Mrs. Johnson admits in her pleadings that she “fired the finance director,” the employee tasked with making payroll tax payments, as soon as she discovered that Koba Institute had not remitted these taxes as required by law.  She also “directed Mr. Johnson to personally handle all future tax payments as of January 2005” and “required” him to provide her with “visual proof” of all tax payments the corporation made.  These admissions indicate that Mrs. Johnson’s status in the corporation during the quarters at issue enabled her to have “substantial input into [its financial] decisions [from 2001 through 2005], had [s]he wished to exert [her] authority.”

Moreover, the fact that, from 2001 through 2004, Mrs. Johnson followed the corporation’s internal policy and did not write checks without knowing that Mr. Johnson had previously approved them does not negate § 6672 “responsible person” status. . . . Although she followed corporate procedure without exception during that time, it is undisputed that Mrs. Johnson ceased following this policy almost immediately upon learning of the 2001-2004 payroll tax deficiencies and could have done so at any earlier time.  Following her “revamped oversight of tax payments,” Mrs. Johnson would write checks from the payroll account without any instruction from Mr. Johnson. . . . Accordingly, the fact that Mrs. Johnson previously chose not to write checks without Mr. Johnson’s approval does not show that she was prevented earlier from doing so other than by her own choice. . . . The record also indicates that Koba Institute opened several operating accounts between 2001 and 2005, and that on each of those accounts, Mrs. Johnson was fully authorized to write checks and execute other bank documents.

While she may not have been running the day-to-day operations of the corporation between 2001 and 2004, Mrs. Johnson had a non-delegable responsibility to monitor Koba Institute’s financial affairs. . . . Mrs. Johnson had the effective power to exercise authority when she chose to do so, even though she chose at times to voluntarily limit her involvement in corporate affairs.  Although Mrs. Johnson often chose not to exercise the authority which she possessed, such a decision is insufficient to permit a taxpayer to avoid § 6672 responsibility. . . . Moreover, after 2004, while the prior periods’ payroll taxes remained unpaid, Mrs. Johnson actively exercised her authority over the affairs of Koba Institute while continuing to receive substantial compensation and benefits from the corporation.  

We therefore conclude that the Government presented undisputed evidence that established as a matter of law that Mrs. Johnson was a “responsible person” under § 6672 during the relevant tax periods because she had the effective power to pay the trust fund taxes of Koba Institute.

Having found Mrs. Johnson a “responsible person,” the Fourth Circuit then turned to the other necessary element of § 6672 liability — whether she “willfully” failed to collect, account for, or remit payroll taxes to the United States.  This inquiry focuses on whether Mrs. Johnson had “knowledge of nonpayment or reckless disregard of whether the payments were being made.”  Plett, 185 F.3d at 219.  The Court readily found evidence of willfulness, as follows:

The record demonstrates that Koba Institute continued to make payments to other creditors using unencumbered funds following Mrs. Johnson’s receipt of the IRS notice in December 2004.  The Government has produced numerous salary checks that the corporation issued to Mrs. Johnson in 2005, which Mrs. Johnson readily cashed.  Yet it is undisputed that Mrs. Johnson, a “responsible person,” knew that payroll taxes for numerous quarters from 2001 through 2004 remained unpaid. Mrs. Johnson’s failure to remedy the payroll tax deficiencies upon learning of their existence in December 2004, while directing corporate payments elsewhere, including to herself, constitutes “willful” conduct under § 6672. This is particularly so given that, at Mrs. Johnson’s direction, Koba Institute paid other creditors during this period. And, as noted earlier, during the 2001 to 2004 delinquent tax periods, Mrs. Johnson received well in excess of $500,000 in compensation and benefits from the corporation while the payroll taxes went unpaid. . . . Even viewing the evidence in the light most favorable to Mrs. Johnson, we conclude that the record allows no conclusion other than that the failure to pay the payroll taxes was willful on Mrs. Johnson’s part.

Based upon its finding that Mrs. Johnson was a “responsible officer” and that the failure to pay employment taxes was willful, the Court affirmed the assessed penalties.

The Johnson case illustrates that personal liability may be assessed against corporate officers where a company fails to pay over employment taxes, even if the corporate officer was unaware of the failure to pay in prior periods.  Once the corporate officer learns of the tax delinquency, he or she has a duty to ensure that corporate funds are used to pay off those liabilities.  If the corporate officer fails to do so, personal liability for those taxes may be asserted.