Parent's president and chairman not liable for subsidiary's payroll tax.

E was M corporation's president and chairman. M owned all of F corporation's stock; F owned all of T corporation's stock. M made E chairman of T. However, E was not involved in the day-to-day operations. Nonetheless, the IRS assessed E, under Sec. 6672, for T's failure to pay over more than $1 million in payroll taxes that T had collected from its employees.

Analysis

The recovery of a penalty under Sec. 6672 depends on whether the person assessed (1) is a "responsible person" and (2) acted "willfully" in failing to collect payroll taxes or pay them over (Davis, 961 F2d 867 (9th Cir. 1992); Buffalow, 109 F3d 570 (9th Cir. 1997)).

Responsible Person

Responsibility is a matter of "status, duty, and authority, not knowledge"; see Davis. A person is "responsible" if he or she has the "final word" on paying bills, meaning "the authority required to exercise significant control over the corporation's financial affairs, regardless of whether [the individual] exercises such control in fact"; see Jones, 60 F3d 584 (9th Cir. 1995). Under Sec. 6671(b), a person includes an officer or employee of a corporation who is "under a duty. to perform the act in respect to which the violation occurs."

An individual's lack of involvement in day-to-day financial decisionmaking or tax matters is irrelevant when he or she has the authority to pay or to order the payment of delinquent taxes. Courts sometimes invoke a nonexclusive list of "factors" in determining responsibility, such as whether the individual had authority to sign checks, served as an officer or director and could hire and fire employees. The most critical factor, however, is having significant control over the corporation's finances.

E was not a person responsible for collecting, truthfully accounting for and paying over payroll taxes withheld from T's employees for the tax period at issue. Although E was chairman of T's board, he did not have the "final word" on which of T's bills would be paid. E was not an officer of T, did not control its day-to-day financial affairs, did not have the ability to sign its checks and otherwise lacked authority to direct the payment of T's delinquent tax liabilities, other than in his role as chairman of T's board. Thus, E's role did not allow him to exercise significant control over T's finances.

Willfulness

Willfulness is shown by "a voluntary, conscious and intentional act to prefer other creditors over the U.S. No bad motive need be proved, and conduct motivated by reasonable cause, such as meeting the payroll, may be willful" (Buffalow, 109 F3d at 573). When a responsible person makes a deliberate decision to pay other creditors, knowing that a tax liability is outstanding, that person acts willfully. After a responsible person knows of the unpaid tax liability, any money coming into the corporation, from any source, must be paid to satisfy both current and accrued taxes.

Willfulness may also be established when a responsible person has no knowledge that other creditors are being satisfied while taxes are delinquent, yet acts with "reckless disregard" of whether the trust fund taxes are being properly paid over. Although mere negligence will not suffice to show reckless disregard, a responsible person may be held liable if he or she clearly ought to have known of a grave risk that taxes were not being paid and was in a position to find out very easily, or failed to investigate or correct mismanagement after being notified of a delinquency in payment.

Even if E were a "responsible person," he did not act willfully or with reckless disregard in failing to pay over the delinquent taxes during the period at issue. He did not prepare payroll, sign payroll checks or direct the payment of other creditors at any time after learning of T's payroll tax delinquency. E took detailed steps to ensure that T's president addressed the deficiency and remained current on the payroll taxes thereafter, steps that might have proved successful if not for the concealment of the continuing arrearages.

After E learned that T's tax liabilities remained unsatisfied, M conferred a "gift" on employees whom T was unable to pay. However, this gift does not establish willfulness, because M's funds were given directly to the employees, without passing through T. E did not direct a loan from M to T for this purpose, nor did he direct T funds to the employees, at a time when he knew that the tax liabilities remained unsatisfied; see Phillips, 73 F3d 939 (9th Cir. 1996).

E also did not act with reckless disregard as to whether T's employment taxes had been paid. On learning of the delinquency, E took immediate steps to address the problem, including meeting with the IRS, directing the president to pay the past due taxes immediately and remain current in the future, and assisting T (in his capacity as M's chairman) in negotiating an agreement to factor T's accounts receivable. E continued to monitor the situation. Although E knew of a grave risk that the taxes might not be paid, he was not in a position to find out easily whether they were being paid, because of T's president's successful concealment of the continuing liability. Thus, E is not liable under Sec. 6672.

DAVID J. SMITH, DC NV, 5/12/04