Written by Guy Schmitz J.D., LL.M.
We can probably agree that there are Code sections that are stupid, too complex, or wondrously ambiguous (leaving us with wiggle room), but there is a combination of Code sections that is truly scary. Taken together, these sections equal the trust fund tax.
The Code Combination
Under Code §§3102(a) and 3402(a), employers must withhold federal income and Social Security taxes from the wages of their employees. An employer holds these taxes “in trust” for the United States and must pay them over on a quarterly basis (Code §7501(a)). Under Code §6672(a) and a heavy body of case law, if the employer withholds the taxes from its employees but fails to remit them, the IRS appropriately gives credit to the employees for having paid the taxes. The IRS then seeks the unpaid taxes from the employer. If the employer cannot pay the taxes, the IRS may assess a 100-percent penalty against responsible persons who willfully fail to collect, account for, and pay over the taxes to the United States.
The Usual Case
In the usual case (to the extent that there are any usual cases), a company is going under, and the man or woman running the company “borrows” the trust fund taxes to pay vendors, who will only deliver goods COD. The company goes under anyway, and the person in charge, who was just trying to keep the company afloat and keep people employed, is hit personally for the “borrowed” trust fund taxes. In other words, there is a look-through, past the employer (say, a corporation) to the responsible and willful person (say, the president).
But It Can Get Worse
Shore v. U.S., 114 AFTR 2d 2014-xxxx (DC ID), 12/04/2014, is a good example of how scary the trust fund tax can get.
William Shore formed Bear Creek Equipment, Inc. (“BRE”), but because Mr. Shore was retired, he left the running of BRE to one Tom Lewis. Although Mr. Shore left the day-to-day operations to Mr. Lewis, Mr. Shore:
• Signed contracts as president of BRE;
• Opened a line of credit for BRE; and
• Personally guaranteed the line of credit.
In August of 2007, the IRS informed Mr. Shore that BRE’s payroll taxes for 2006 and 2007 had not been paid. The taxes weren’t paid because, as the Court said, Tom Lewis was an embezzler, failing to pay taxes and creditors and stealing BRE’s assets. Before closing BRE, Mr. Shore allowed more than $120,000 from BRE’s checking accounts to be paid to unsecured creditors other than the United States. Mr. Shore paid about $101,600 in trust fund taxes but lost his refund suit in the Idaho District Court. The trust fund cases have two tests, both of which Mr. Shore met.
The Responsible Person Test
Mr. Shore was the responsible person. While he allowed Mr. Lewis to run BRE’s daily affairs, he remained a responsible person “because [as the Court said] he had effective control over the corporation and the effective power to direct the corporation’s business choices, including the withholding and payment of trust fund taxes.”
The Willful Test
The willful test doesn’t have anything to do with good or bad motives. This term refers only to a voluntary, conscious, and intentional act to pay other creditors over the United States. Mr. Shore had $120,000 paid over to creditors other than the United States; as a result, he was personally liable for about $101,600 of trust fund taxes.
The Court was sympathetic to Mr. Shore but made it clear that the United States cannot be an unwilling partner in a failed business venture.