Most business owners and managers are well aware of their federal payroll tax obligations. Many an owner or manager has been up until the wee hours of the morning completing payroll tax paperwork. But many owners and managers are not aware of their personal liability for payroll taxes or how the IRS can build a case for an owner’s or manager’s personal liability. A recent IRS memorandum provides guidance to IRS agents on documenting payroll tax cases against owners and managers.
A business must withhold income taxes from employee pay. The business must account for this tax money and send it promptly to the IRS. Failure to do so not only makes the business responsible for the shortfall – it may also make an owner or manager personally responsible as well.
The IRS views payroll taxes, withheld by a business, as trust fund money. Therefore, business owners and other “responsible persons” have personal liability for these taxes. “Responsible persons,” under the federal tax law, may include owners, company officers, or managers. The IRS can assess a Trust Fund Recovery Assessment – which is essentially a 100% penalty – against every responsible person. In situations where payroll taxes are not properly paid, the IRS often makes an assessment against every manager, officer or owner and waits for them to turn on each other. One officer or co-owner may get stuck with the penalty, while others will owe nothing.
A recent IRS memorandum, issued by the National Director of Collection Policy to the IRS’ regional agents, states that IRS agents should determine, on a case-by-case basis, the amount of documentation required to assert a penalty. Key factors for this determination are an individual’s “responsibility” and “willfulness.” In determining “willfulness,” the IRS and federal courts generally focus on an individual’s knowledge regarding the failure to pay taxes and whether the individual showed reckless disregard for tax payments.
Unfortunately, an individual need not actually perform the withholding and payment duties to be deemed “responsible.” If an individual has signature authority (even if unexercised) while other payments (not to the IRS) are made, that can be enough for the IRS to assert personal liability.
Recently, the IRS has imposed personal liability on owners in the following situations:
- A couple formed two companies, held the top management offices for both companies and managed the companies’ day-to-day business. Both spouses possessed the authority to sign tax returns on behalf of both companies and signed payroll checks for both companies. They also signed for bank notes and security agreements and served as personal guarantors. However, they hired a bookkeeper to be responsible for paying payroll taxes. Their bookkeeper later died and was found to have embezzled from the companies. The IRS found willful nonpayment for the couple when the couple sold the companies and chose to pay employees and third-party creditors, rather than the IRS.
- A company owner was held liable for back payroll taxes, and the 100% tax penalty, despite his claims that he had been duped by his bookkeeper into believing that the taxes were paid. The IRS ultimately dismissed the bookkeeper and pursued the owner. A federal court found that “willfulness” existed when the owner turned over funds to the bank and other creditors rather than the IRS, after it was proven that the owner knew of the tax obligation.
The following are the types of documentation which the IRS will use to determine whether an owner or manager should have individual liability:
- Form 4180 Interviews: The IRS will conduct interviews with each potentially responsible person using its Form 4180. The IRS will inquire about an individual’s duties with the business, the actions that individual took to ensure that taxes were paid, and the duties of the other owners or managers.
- Articles of Incorporation.
- Bank signature authority cards.
- Copies of cancelled checks which demonstrate payment to other creditors – not the IRS.
Of course, if the IRS can’t easily obtain these records from the business itself, it will get these records using a subpoena.
IRS agents are directed to exercise their judgment regarding the amount of documentation needed to support a tax penalty. Agents may ask for more documentation. However, the above items are often enough to impose and support the tax penalty.
If you have reason to believe that payroll taxes are not being paid in a business which you own or manage, you should seek professional guidance. You should feel free to contact a member of the McGrath North Tax Group.