Source: http://archives.cpajournal.com/1997/0297/features/f30.htm
Timestamp: 2019-04-25 01:47:58+00:00

Document:
Accountants in industry or those who serve in a managerial or bookkeeping capacity for their clients may be considered "responsible parties" for entities that fail to remit withheld taxes to the IRS. As a responsible party, they are personally liable for a 100% penalty for such taxes. Who is a responsible party has been determined largely by the courts, and they have developed a number of characteristics for identification. Knowing these characteristics, accountants can take steps to avoid being a responsible party and paying this onerous penalty.
One of the largest potential sources of personal liability for an accountant is in the area of employee withholding taxes. Accountants should be aware of the liabilities and penalties they and their clients confront in situations where a company has not paid employee withholding taxes to the IRS. There is a 100% penalty the IRS may impose to facilitate the collection of these taxes. The "100% penalty" was renamed the "trust fund recovery penalty" by the IRS in 1993. However, the term "100% penalty" continues to receive widespread usage.
It is not unusual for businesses to encounter cash flow problems. Businesses that have adequate credit can secure a short-term infusion of cash from traditional sources such as banks. In closely held businesses, cash shortages are often alleviated by the owners. However, many businesses do not have these resources available, and must continue to pay creditors and employees. Firms that confront this situation have been known to resort to using payroll taxes as a temporary source of working capital rather than closing the business. Obviously, businesses using payroll taxes for temporary cash infusions believe they will be able to repay the taxes before the IRS determines payroll taxes have not been paid.
Several problems result from using payroll taxes as a source of working capital. First, even if a business is able to repay the taxes, the penalties and interest charged by the IRS are exorbitant. Second, in labor intensive industries, the liability can quickly become an untenable financial burden. Third, if the corporation is unable to pay the payroll taxes, certain individuals can be held personally liable for a portion of the payroll taxes.
Employers are required to withhold federal income taxes and social security (FICA) taxes from their employee wages and are liable for payment of these taxes to the IRS. The employer does not have to segregate withheld funds from other funds available. However, these funds are considered to be held in trust and cannot be spent for any purpose other than remittance to the government. In Slodov v. U.S., [436 S. Ct. 238 (1978)], these funds were referred to as "trust fund taxes," a term commonly used when referring to employee Federal income and FICA taxes. It is important to note that trust fund taxes do not include the employer's matching portion of FICA taxes.
To facilitate the collection of unpaid trust fund taxes, persons statutorily responsible for making sure the taxes are paid are held personally liable. The IRS will seek a 100% penalty against certain individuals considered to be responsible parties for the payment of trust fund unpaid withholding taxes. The penalty is in addition to any other penalties that may be properly assessed. The penalty does not apply to the employer's portion of FICA and to federal unemployment taxes.
An individual who has a responsibility to collect withholding taxes imposed on another person and remit the taxes to the IRS is considered a responsible person. For the responsible person to be assessed the 100% penalty, there must be a willful failure to collect and pay over the taxes. Responsible persons can include officers or employees of a corporation, members or employees of a partnership, creditors who purchase a business, bookkeepers, consultants, volunteer members of a board of trustees, and lenders.
In many situations it is difficult, based solely on the IRC, to determine who the responsible person is and whether there is a willful failure to collect and pay the taxes. The ultimate determination of responsible persons is often decided upon by the courts. The courts have taken a broad view of the term "responsible person," repeatedly stating the penalty should be imposed on persons who have the ultimate authority to decide the priority of bill payment and who willfully pay other creditors, rather than paying the payroll taxes. However, there is no single criterion used in determining this authority. Court cases have set forth the common identifying characteristics of a responsible person. A few landmark cases establishing these characteristics are discussed below.
In White, v. U.S., [372 F.2d 513 (Ct. Cl. 1967)], the court sought to define the responsible person. Robert White, president of White Plumbing, Inc., had the ultimate authority to decide which creditors to pay and when, and therefore was a person under a duty to collect and pay over withheld income and FICA taxes. White did not prepare the payroll tax returns, pay the wages, or withhold payroll taxes; however, he was assessed the 100% penalty because he willfully (voluntarily, consciously, and intentionally) failed to pay the taxes and made the ultimate decision not to pay them. This case opened the door for assessing the 100% penalty against persons who possess ultimate authority but are not directly involved with the payroll process.
In Gustin v. U.S., [88 F.2d 1370 (5th Cir. 1989)], the Court of Appeals reversed a lower court decision that assessed Gustin the 100% penalty for failing to pay over withholding taxes. The Court of Appeals found evidence that showed Gustin did not willfully fail to pay the taxes and did not have effective power to pay the taxes. Although Gustin was the president of the company, he had no control over or access to the company's books and financial records, and he had no responsibility for calculating or paying the company's taxes. This case establishes that a mere corporate title may not be sufficient to assess the 100% penalty.
In Watson v U.S., [583 F. Supp. 1166 (Ariz. 1984)], the court found Watson was not a responsible person even though he paid the bills and signed the checks. Watson acted under the direct authority of the corporation's president, who alone determined which creditors would be paid. The court found the duties of signing checks and preparing tax returns were not solely determinative of liability.
In Howard v. U.S., [711 F.2d 729 (5th Cir. 1983)], a corporate officer who possessed and exercised authority over the payment of corporate obligations argued he was not a responsible person relative to trust fund taxes because his superior specifically instructed him not to pay the payroll taxes. The court found that after he was told not to pay trust fund taxes, he continued to determine which other creditors to pay and therefore had sufficient authority over the allocation of corporate funds. The payment of other bills reduced the amount available for payment of trust funds. Howard argued that he would have been discharged from employment if he had paid the trust fund taxes. The court agreed this was a cruel dilemma, but was not a defense. The court found that a responsible person should pay the taxes even if it means loss of employment. This case established that a responsible person will not be absolved of responsibility solely because a corporate superior orders that the IRS not be paid.
In Schroeder v. U.S., [900 F. 2d 1144 (7th Cir. 19900], Schroeder, the chief financial officer, signed checks on behalf of the corporation. She received instructions from the chief operations officer each week as to which bills to pay and was specifically directed not to remit trust fund taxes. She did not have discretion over which bills to pay. She merely wrote the checks as directed by her superior, who made the ultimate decision. Unlike the Howard case, the court found Schroeder was not a responsible person because she lacked control over daily business activities and lacked authority to pay other creditors.
To better understand the types of situations in which an accountant may be personally liable for trust fund taxes, three fictional cases are presented describing real world scenarios. After each fictional case, the solution is given and is supported by a similar actual case.
Case 1. Jack Debit, a recent accounting graduate, is hired by Alpha Contractors, Inc. as its controller. He is immediately made an officer of the closely held corporation and has signature authority on all corporate checking accounts. He soon discovers the company has a significant outstanding payroll tax liability. After discussing this situation with the owner, it is agreed that all future payroll withholding taxes will be paid in a timely manner. The owner gives Mr. Debit complete authority over paying the bills. Mr. Debit pays all the payroll withholding taxes subsequent to his employment. However, the payroll tax liability created prior to Mr. Debit's employment is not paid. Alpha Contractors, Inc. now faces bankruptcy. Is Mr. Debit considered a responsible person and/or is he personally liable for the trust fund taxes that existed prior to his employment?
Although Mr. Debit is a responsible person, he can only be held liable for failing to pay over funds generated after he assumed control. In Slodov v. Comm [436 S Ct 238 (1978)], a corporate officer was not personally liable for failure to pay over the corporation's withholding taxes even though he was a responsible person. Although Slodov knew withholding taxes were unpaid when he became a responsible person, he could use later acquired funds to pay other debts of the corporation prior to Slodov's employment with the business. However, Slodov could be held personally liable for unpaid employee withholding taxes subsequent to his employment.
Case 2. Jane Credit has been employed by a CPA firm for several years. She believes there is a market for client write-up services and decides to resign from the CPA firm and start her own business. One of her first clients, Apache Labor Crews, Inc., requests that she handle its entire accounting function, including preparing the payroll and paying creditors. For convenience, Ms. Credit is given check-signing authority and determines priority for bill payment. For several months, she does not pay the payroll taxes due to a cash shortage. When Ms. Credit confronts the president about the unpaid payroll taxes, he explains that cash flows are always insufficient this time of the year and should get better in a few months. She continues to pay the other debts of the firm. After several months of not paying the payroll taxes, the president absconds with all the cash in the corporate accounts and leaves the country. Apache Labor Crews, Inc. files for bankruptcy. Is Ms. Credit considered a responsible person and/or personally liable for the trust fund taxes of Apache Labor Crews, Inc.?
Ms. Credit is a responsible person and is personally liable for the trust fund taxes. In a landmark case involving accountants, Quattrone Accountants, Inc. v. U.S., [895 F.2d 921 (3rd Cir. 1990)], Quattrone Accountants, Inc. was found liable for trust fund taxes of a third party. Quattrone Accountants, Inc. was an accounting firm that contracted with United Dairy Farmers Cooperative Association to handle all accounting and financial affairs on a daily basis, and in doing so made itself a responsible person. Although the firm had no control over hiring and firing of the co-op's non-accounting employees, it signed the co-op's checks, paid its bills, and prepared its tax returns. Even though the accounting firm declared bankruptcy, the court found its owners had acted in "reckless disregard" of its responsibility and assessed them the 100% penalty.
Case 3. Ralph Fifo is the chief financial officer for Quality Shipyard, Inc. The shipyard is facing hard times and is using payroll taxes as a source of working capital. Quality Shipyard owes $250,000 in payroll taxes. Approximately $150,000 represents employee withholding taxes and the remaining $100,000 represents the employer's payroll tax portion. Since Mr. Fifo is vaguely familiar with the personal liability exposure he may have relative to payroll taxes, he sends the IRS a check for $150,000 as soon as the funds become available. Has Mr. Fifo eliminated his personal liability relating to the unpaid payroll taxes of Quality Shipyard, Inc.?
Mr. Fifo may not have eliminated his personal liability. The courts decided in Wood v. U.S., [808 F.2d 411 (5th Cir. 1987)], that in the absence of specific instructions as to the disposition of a voluntary payment made by the taxpayer, the IRS can apply the payment to any outstanding tax liability, including the employer's FICA match. In O'Dell v. U.S., [326 F. 2d 451 (10th Cir. 1964)], the court applied a voluntary payment to the trust fund taxes because the taxpayer gave specific written directions with the payment. Accordingly, the payment of $150,000 by Mr. Fifo could first be applied to the employer's match, then to the employee withholding taxes because there was no direction as to the application of the funds given with the payment. Therefore, $100,000 of trust fund taxes may remain unpaid, for which Mr. Fifo may be personally liable.
*	Ultimate authority for the decision not to pay trust fund taxes.
*	Ultimate authority over the expenditures of funds or the authority to direct payment to creditors.
*	Discretion regarding which bills other than trust fund taxes are to be paid.
*	Significant control or authority over the business entity's general finances or general decision making.
*	Preparation and signing of payroll tax returns.
*	An officer or director of the corporation.
*	Ability to hire and fire employees.
*	Stockholder of a corporation or partner of a partnership.
The IRS and courts will consider all of the identifying characteristics of the individuals involved and the specific circumstances surrounding each case. However, the focus will be on who has the ultimate authority over the financial affairs of the business.
In the event there is more than one responsible person, the IRS can choose the person from whom it will collect. This usually means the IRS will go after the responsible person who has the greatest wealth and is most easily accessible. However, because the 100% penalty is a tax collection device, the IRS will collect the penalty only once. Therefore, once the IRS collects the penalty, assessments against other responsible persons will not be pursued. When the IRS collects from a particular responsible person when there are several other responsible persons, litigation will probably be brought by the assessed individual against the other responsible person(s) and the company to recover the amounts paid.
*	Prior to accepting employment with a company, an applicant should try to determine the company's history related to the timely payment of payroll taxes. This could include reviewing financial statements and payroll records and talking to key accounting personnel. An outstanding payroll tax liability or a history of not making timely payments of payroll taxes is a warning to seek employment elsewhere.
*	The authority to sign or co-sign checks without the ultimate responsibility over allocation of corporate assets may expose the accountant to unwanted liability.
*	In the event an accountant believes he or she may be considered a responsible person because of position or job duties, without discretion over which creditors to pay, the accountant should obtain written evidence from his or her superior of this limitation.
Shawn Mauldin, CPA, is a doctoral student and W. Mark Wilder, PhD, CPA, an assistant professor of accounting, both at the University of Mississippi.

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