Can Your Accountant Owe Your Payroll Taxes?

You own an accounting firm. A potential client is willing to pay you $4,900 month to do their accounting, including payroll. You will be writing checks and paying vendors, including deposits with the IRS.

Are you interested?

What can go wrong, you ask. Since this is a tax blog, you can anticipate that someone is going to step on the IRS’ or state tax agency’s tail, but that does not means that someone is automatically wrong. A significant part of my practice is representation, for example, which usually entails arguing that my client is right.

Buddy and Barry are brothers and together own an accounting firm. There is a North Carolina entrepreneur (Erwin) who owns or operated at least 60 restaurants. He has a new deal to start a Golden Corral franchise, which he does under the name GCAD. There will eventually be five franchises under GCAD. 

The restaurants start to lag. There is negative cash flow of approximately $2 million. Understandably, GCAD has difficulty paying its creditors. Erwin hires a new business manager (Pintner), who knows Buddy and Barry.  They are hired to handle the accounting and taxes for GCAD.

Buddy and Barry obtain data by accessing the restaurant computers remotely. After running payroll, they send the checks to Pintner for distribution to employees. GCAD allows them direct access to the bank account to remit withholdings. They do not need further authorization to make payroll tax deposits.

They are also responsible for paying vendors, but that process is a bit different. Initially they send checks for signature, but eventually they are given a signature stamp.

By the way, remember that they too are a vendor of GCAD. They are paid $4,900 a month.

The brothers are aware of the cash stress. They inform GCAD and Erwin that there is not enough money to pay everybody.

Erwin learns that the brothers had failed to remit payroll taxes. He and another partner fund a capital call, sending the brothers $150,000 with the following instructions:

“that absolutely under no circumstances whatsoever were [you] to be late with any taxes.”

That did not seem to take, and GCAD is again late with payroll taxes.

Business does not improve. Erwin obtains release from one of the leases. GCAD goes three more quarters without remitting payroll taxes. Erwin and his partners make another capital call.

Erwin eventually fires Buddy and Barry. He moves the accounting to North Carolina, and GCAD gets current with its payroll taxes. GCAD however does not pay its back taxes. It can’t. It needs all the money it has to remain in business.

GCAD finally folds.

Uncle Sam shows up, and he wants his payroll taxes. Erwin pays some, then immediately countersues to get the monies back. The IRS starts swinging, suing Erwin and Pintner and Buddy and Barry.

Erwin lawyers up. Pintner lawyers up. The brothers do not. They show up in court “pro se,” which means they are representing themselves. I consider that decision to be suicidal.

Why suicidal? The IRS considers the brothers a “responsible person,” and the IRS has a point. The brothers did have quite a bit of discretion over who was paid with the limited cash available. The IRS argues that it gets paid first, a point they are now emphasizing by going after Erwin and Pintner and the brothers for trust fund penalties. This is the “big boy” penalty, and it is 100 percent of the withholding taxes.

How did it turn out? Read the court’s verdict for yourself:

... the Light Brothers are jointly and severally indebted to the United States for the unpaid withholding taxes assessed against them, plus the applicable interest accruing according to law.”

The tab?  Try $325,734.

The monthly $4,900 fee was sweet, but not enough to cover the penalty.

Could representation have saved the brothers? I am speculating at this point, but I do not believe so. The brothers took on too many of the trappings of a corporate officer. The IRS would be harsh on their control over the checking account, for example. The IRS takes priority when it comes to payroll withholdings, and it reserves the right to disregard other vendors – even if not paying other vendors would put one out of business. The brothers paid other vendors (including themselves) before paying the IRS.  They walked directly into the IRS crosshairs.