The IRS refers to it as the “responsible person” penalty.  It applies to failure to remit withheld federal payroll taxes.  You can think of federal withholding taxes as having five pieces, as follows:

·         Federal income tax withheld

·         Social security withheld

·         Medicare withheld

·         Employer match of social security

·         Employer match of Medicare

Here is the concept: the IRS considers the first three to be the employees’ money, which the employer holds in trust. When the employer fails to remit these, it is not only tax noncompliance but also theft. The IRS is very harsh on this issue and will impose one of its harshest penalties: the “responsible person” penalty. This penalty is 100%. Yes, you read that correctly.

You never want to be “responsible” for this purpose. The IRS can chase to ground anyone it considers responsible and assess the penalty. It doesn’t matter whether you own the company, or are an officer, or even still work there. 

Think about the math for a moment. The company falls behind on its payroll taxes. The IRS will proceed against the company for the taxes. If it then chooses to assess penalties, it does so against the responsible person. That penalty is 100%. The company pays. The responsible person pays. The IRS is paid twice.

Let’ go over a quick example: Let’s say that the amounts are as follows:

·         Federal income tax                 $1,800

·         Social security withheld         $   336

·         Medicare withheld                 $   116

·         Employer social security        $   496

·         Employer Medicare                $   116

When the IRS goes against the company, it will want a check for $2,864 ($1,800 + 336 + 116 + 496 + 116).

NOTE: The employer social security is higher than the employee withholding because of the 2-point reduction in employee social security for 2012.  The employer percentage remained at 6.2% whereas the employee share was reduced to 4.2%.  This was part of the effort to stimulate (or at least not de-stimulate) the economy. It is also slated to expire at the end of 2012.

If the IRS assesses the responsible person, that penalty will be $2,252 ($ 1,800 + 336 + 116). Notice that the employer share doesn’t count for purposes of this penalty. Small consolation.

There are two major tests that the IRS will consider to determine if someone will be charged with the “responsible person” penalty:

(1)   Did the person have a responsibility to collect, account for and pay the trust fund taxes; and

(2)   Did the person willfully fail to perform this duty?

Let’s break down the first test. What if you are a payroll manager, responsible for running payroll and correctly accounting for withholding taxes? Are you responsible? No, not by itself, because you do not have authority to pay bills and write checks. What if you are the treasurer, with authority to write checks? Are you responsible? You will have the IRS’ attention, but the technical answer is no, not by itself. In our next blog we will discuss a taxpayer who wrote over 1,800 checks but argued that he was not a responsible person. The IRS did not believe him, of course, so off they went to court.

On to the second test. We are presently representing a responsible person client on the issue of willfulness. Willful means that one voluntarily and intentionally paid, or continued to pay, other creditors while knowing that the company failed to pay over withheld funds to the government. The IRS in the past has argued that payments to a creditor – mind you, any payments to any creditor – could be sufficient to show willfulness.

Fortunately the courts have slowed down the IRS. Let’s say the check writer was unaware of the lapsed payroll deposits, for example. How? One way is lack of financial sophistication. What if the bookkeeper “took care of it,” and the bookkeeper suddenly took ill, became disabled or left town? The business owner or manager could well need time to ramp-up, whether that means payroll, using QuickBooks or any other duty previously performed by the bookkeeper. Can one say there is “willful” intent while the owner or manager is struggling through the learning curve? Let’s swing the other way and say the check writer was financially sophisticated. What is your opinion if told that the check writer wrote checks only infrequently, and that when the primary signor was on vacation or otherwise unavailable? What if the check writer was unaware of any payroll problems? What if the check writer is authorized pay to vendor payables but excluded from any payroll responsibilities? What if the check writer was intimidated by his/her boss?

This area is of concern because of the poor economy in the last several years. There is great temptation to consider payroll taxes as yet another funding source, reasoning that the IRS can wait like any other creditor. That is not true. The IRS is not just any other creditor. The IRS can assess and collect tax for 10 years past the assessment date, and longer than that if it reduces the assessment to a judgment. And do not assume this is automatically dischargeable in bankruptcy court.  This is called “expensive money.”

Next blog: we will talk about Tarpoff and his responsible person penalty.

Hazard of Being a Volunteer Nonprofit Director

Can you be on the hook for unpaid payroll taxes if you are a volunteer director for a nonprofit? What if you do not have authority to write checks?

Let’s take a look at the recent (March 8, 2012) U.S. District Court decision Bunch v Commissioner.

Perceptions, Inc. was a Tennessee nonprofit formed in 2004, Perceptions provided supportive living service for developmentally disabled clients. The incorporators and initial directors were replaced by Roy Don Bunch (Bunch) and two others. Documents filed with Tennessee listed Bunch as the chairman of the board. He was also the registered agent.

Bunch was benevolent with Perceptions. He allowed it to use one of his properties rent-free. He also made start-up loans and – later – bridge loans when Perceptions did not have sufficient money to pay its bills. His generosity was not insignificant. Between February, 2005 and August, 2007, Bunch made loans of approximately $648,000.

When Perceptions had money, it would repay him. Between 2006 and 2007 Bunch was repaid approximately $558,000.

Bunch never received a paycheck. He never hired or fired employees. He never asked to see the books. He never asked if taxes were being paid. He did speak up in December, 2006 when he learned that Perceptions was thinking about employee raises. His question was reasonable: we are almost bankrupt. Why are we talking about raises? No raises were given, but Bunch’s hopes for a Congressional career were jettisoned.

In December, 2006 Bunch learned that quarter 3, 2006 employment taxes were unpaid. He loaned money to Perceptions to pay these taxes.

In June, 2007 he finally gave up and took over financial responsibility, including writing checks. He was hoping to make Perceptions a viable business. Payroll was met, providers were paid and Bunch was repaid on his loans. Perceptions however did not pay its current or back employment taxes.

The IRS finally shows up wanting to know what is going on. In March, 2008 the IRS decides that Bunch is a “responsible person” for the second and fourth quarters of 2006 and all of 2007.  You do not want to be a “responsible person,” as this means the IRS is coming after you. The IRS wanted almost $194,000 from Bunch.

Bunch was an inquisitive sort. His attorney asked the IRS for their basis in concluding that Bunch was a “responsible person.”  The IRS sent the attorney copies of an interview questionnaire but no reasoning or other basis for their determination.

Bunch filed an appeal on April 25, 2008.

Summer comes. Fall comes. Winter comes. In January, 2009 Bunch received a letter from IRS Appeals. They want affidavits and documents, which he provides. What he did not receive, however, is the basis on which the IRS concluded he was a responsible person.

Spring comes. Summer comes. In September the IRS tells him to pay the penalties. They again fail to tell him why.

In October, 2009 Bunch filed a Request for Abatement. He attaches and documents everything.

The IRS tells him his claim would open for review on January 10, 2010. Two weeks later – January 25 – Bunch receives the IRS’ denial of his claim. Bunch can almost hear the tires squealing as the IRSmobile speeds away. The IRS still failed to tell him why he was responsible.

On February 9, 2010, Bunch sends the IRS almost $194,000. He then files a court motion. He wants his money back. And to find out why he is responsible.

In court Bunch admits that he was a responsible person as of June 22, 2007, when he took over financial responsibility for Perceptions. He disagreed that he was a responsible person before that date. He had a point. One of the key indicators is whether the person in question had discretion over cash disbursements, including signature authority. A bookkeeper who pays what he/she is instructed to pay would not be a responsible person, whereas his/her boss could be.

The court disagreed with Bunch. It did not matter that he did not hire or fire, have ownership, get paid or write checks. The court reasoned that he had authority as a director and significant financial authority because he lent a lot of money to Perceptions. In fact he could have forced Perceptions out of business by simply not loaning them money. The court did not care that he did not know or did not exercise authority. The court reasoned that he could have, and “could have” was sufficient.

Bunch was a responsible person for all periods. The IRS could keep his $194,000.

Yipes!

My take: sadly, I have to agree with the court. There is a long-standing tax doctrine that one cannot intentionally stick his/her head in the sand and claim ignorance. Bunch was involved enough to lend Perceptions money on an almost-monthly basis. As a director, he had the right to ask why, where the money was going, what bills were being paid and – importantly – what bills were not being paid. He already had one fright with unpaid employment taxes, and it was not unreasonable for a director to oversee that such taxes not be overlooked in the future.

The difficult part here is separating his duty as a director from his obvious generosity with the charity. As director he had authority to inquire, berate and insist. Events came to his attention which reasonably required him, as director, to get involved. It was not reasonable for a director to turn a blind eye. He was a tremendous benefactor, but not a very good director. Had he just been a benefactor, I doubt the court would have arrived at the same decision.

On April 6 Bunch filed a motion seeking to alter or amend the court’s decision. We’ll see how it turns out, but I doubt he will be pleased.