Lack of Control Does Not Except Owners from Trust Fund Recovery Penalty

Practice & Procedures

The owners of a company who had delegated payroll functions to a separate payroll company they owned but did not operate were liable for trust fund recovery penalties because they were responsible persons both before and after the withholding taxes that were the basis of the penalties accrued.

Background

In 1992, James and Gayle Oppliger formed Double O, a trucking business, and served as the sole owners and primary officers of the company. In 1997, the Oppligers formed LFC, a payroll company for Double O. The Oppligers were the sole members of LFC. All of Double O’s employees except Gayle became LFC employees after the Oppligers established LFC. LFC provided payroll services only to Double O.

In 1996, the Oppligers hired Mary Kerkman to perform accounting and bookkeeping services for the companies. The Oppligers delegated to Kerkman the tasks of filing employment tax returns and paying payroll taxes. Kerkman provided the Oppligers with weekly reports that informed them of the companies’ financial situations. Kerkman committed suicide on April 3, 2002. After her death, the Oppligers learned that Kerkman had embezzled $10,000 from the companies.

On April 4, 2002, the day after Kerkman’s death, an IRS revenue officer visited the companies’ offices and asked the Oppligers why they had not appeared at a meeting with her. The IRS officer informed them that LFC had not paid employment taxes to the government for 13 consecutive quarters, and Double O had not paid employment taxes for 17 quarters. The Oppligers stated that they did not know about the meeting and later claimed that the revenue officer’s visit was when they first learned that Double O and LFC had not been paying their employment tax liabilities.

The Oppligers subsequently sold the assets of Double O on September 1, 2002. Between April 4, 2002, and September 1, 2002, LFC paid over $2 million to its employees and over $3 million to third-party creditors. Under Sec. 6672, the IRS assessed trust fund recovery penalties against the Oppligers for LFC’s unpaid taxes of approximately $2.36 million and Double O’s unpaid taxes of approximately $27,000. The Oppligers each paid $15,015 toward LFC’s tax obligations.

The Oppligers then filed claims for refund with the IRS, which the IRS denied. The Oppligers brought suit in district court, requesting a refund of the employment taxes paid and a ruling that they were not liable for the trust fund recovery penalties. The district court granted the IRS summary judgment in the case. The court found that, even assuming Kerkman provided the Oppligers with false reports and embezzled from the companies, there were no genuine issues of material fact regarding whether the Oppligers were responsible persons under Sec. 6672 and that the Oppligers willfully failed to pay employment taxes because they admitted that after the IRS informed them of their outstanding tax liabilities, they paid employees and third parties over $5 million. The Oppligers appealed this decision to the Eighth Circuit.

The Law

Under Sec. 6672, when an employer fails to remit withholding taxes, any person who (1) is a responsible person with respect to the taxes and (2) willfully fails to pay them over to the United States is liable for penalties (trust fund recovery penalties) of 100% of the withholding taxes not paid. An employer holding withholding taxes in trust may not use the taxes for any other purpose (Slodov, 436 U.S. 238 (1978)).

The Eighth Circuit’s Decision

The Eighth Circuit affirmed the district court and held that the Oppligers were liable for trust fund recovery penalties based on the unpaid employment tax liabilities of LFC and Double O, finding that the Oppligers were both responsible persons and had willfully failed to pay their withholding tax obligations. Noting that the Oppligers were the sole owners and directors of Double O, were the creators and owners of LFC, and exercised full authority over (including signing payroll checks for) both companies, the court first found that they were responsible persons for the companies for purposes of Sec. 6672. The court then considered whether they had willfully failed to pay the trust fund taxes.

Besides claiming that they were not responsible persons, the Oppligers argued that when the IRS informed them of the unpaid employment taxes and they reassumed control over the payroll functions of their companies, they did not have unencumbered funds available to pay the taxes owed. According to the Oppligers, under the Supreme Court’s decision in Slodov, their potential liability as responsible persons under Sec. 6672 was limited to the amount of their unencumbered funds at this time.

The Eighth Circuit stated that the Oppligers erred in relying on Slodov because in that case, the person against whom the IRS had asserted trust fund recovery penalties had not been a responsible person when the three companies he controlled accrued the withholding tax liabilities on which the penalties were based. Instead, he had become a responsible person only when he took over control of the three companies, which was after they had accrued the liabilities. Under that scenario, if no funds were available to pay the outstanding withholding taxes when the person assumed control and became a responsible person for the companies at issue, he or she did not willfully fail to pay the companies’ outstanding withholding liabilities by not paying those liabilities with funds the companies later generated.

However, unlike the person in Slodov, the Oppligers were responsible persons for all the periods in which their companies accrued the unpaid withholding tax liabilities. Therefore, the exception from Slodov did not apply, and the Oppligers, as responsible persons for LFC and Double O, had willfully failed to pay the companies’ withholding tax liabilities. Consequently, they were subject under Sec. 6672 for trust fund recovery penalties on those unpaid liabilities.

Reflections

This case once again shows that the IRS and the courts will very rarely excuse owners of business entities who are responsible persons under Sec. 6672 from trust fund recovery penalties for withholding taxes, regardless of why the withholding taxes were not paid. Thus, it is imperative for practitioners to make sure that a client who qualifies as a responsible person fully understands that the IRS can assert trust fund recovery penalties if the client’s business fails to pay the full amount of withholding taxes it owes.

Oppliger, No. 10-2011 (8th Cir. 3/29/11)