The courts look at sec. 6672 TFRP.

Courts have long been asked to determine who is a "responsible person" under the Code's Trust Fund Recovery Penalty (TFRP) provisions. The majority of recent decisions in some way held for the Government. Practitioners can use these results as a guide to the factors which go into sustaining--or avoiding--a TFRP assessment.

Background

Sec. 6672 provides that, "any person required to collect, truthfully account for, and pay over any tax imposed by this title who willfully fails to collect such tax, or truthfully account for and pay over such tax, or willfully attempts in any manner to evade or defeat any such tax or the payment thereof, shall, in addition to other penalties provided by law, be liable to a penalty equal to the total amount of the tax evaded, or not collected, or not accounted for and paid over" Simply put, when a business withholds payroll tax deductions from its employees, and fails to pay these "trust funds" to the government, the Service can "pierce the corporate veil" and collect an equivalent amount of money directly from any "responsible person." This civil penalty, previously known as the 100% penalty, is now called the TFRP.

If more than one person is deemed liable, the amount of the penalty is not apportioned; each is assessed the same amount of the trust funds not paid for in the periods when they shared liability. When this happens, all parties receive credit for each other's subsequent payments. They also receive credit for any payments made by the collecting entity (the corporation), which reduce the unpaid trust fund amounts.

Assessment of a penalty is made after investigation and recommendation by a revenue officer. The recommendation can be appealed administratively to the IRS's Office of Appeals. However, an adverse decision by Appeals cannot be further appealed to the courts.

To obtain judicial review, a person must pay part of the assessment and then file a claim for a refund. The amount paid should be equal to the tax withheld from one employee for one calendar quarter; if this amount cannot easily be determined, a token amount, such as $100, is normally paid. When the individual's claim for refund is denied, he may bring a suit to recover the payment in either U.S. District Court or the U.S. Court of Federal Claims. This gives the court jurisdiction to determine the liability of the parties involved.

Court Tests

The courts look at two tests in determining whether to uphold an IRS assessment of the TFRP--was the individual a responsible person, and was the failure to pay over the funds

In Doyle (1999), the Court of Federal Claims quoted various cases to define a responsible person. According to Slodov, 436 US 238 (1978), "the `responsible person' must be under a duty to collect, truthfully account for, or pay over taxes." Per Greenberg, 46 F3d 239 (3rd Cir. 1994), "responsibility is a matter of status, duty or authority, not knowledge." Godfrey, 748 F2d 1568 (Fed. Cir. 1984), cautioned that, "the test of responsibility `is a test of substance, not form.'"

Two cases hint at a possible exception for a taxpayer who only appears to have status, duty or authority. Referring to McCarty, 437 F2d 961 (Ct. Cl. 1971), the court noted, "if a person comprehensively delegates power and `lacked the ultimate authority to withhold and pay the employment taxes in question' then that person will not be held to be a `responsible person.'" Additionally, "the basis for a responsibility finding is `lacking ... where the taxpayer assumes a title merely for the purpose of protecting his investment'" according to O'Connor, 956 F2d 48 (4th Cir. 1992).

Interestingly, recent court cases focus more on the question of responsibility, giving much less attention to the question of willfulness. Despite the two-pronged test described, most cases turn on responsibility, while only a few are decided based on willfulness (when a person has already been determined to be responsible). Some taxpayers have been held to be responsible, but not willful. A question for future consideration might be whether it is possible to be willful, but not responsible.

Summary Judgment

Once a case goes to court, the Service usually seeks summary judgment. This is a finding by the court indicating that the government wins its case as a matter of law because there is no question about the case's facts. Taxpayers also often seek summary judgment, arguing that they were not responsible or willful as a matter of law--again, with no question as to the facts.

Federal Rule of Civil Procedure 56 provides that a moving party (i.e., whoever asks for summary judgment) is entitled to win when there are no genuine issues of material fact in dispute, and when that moving party is entitled to judgment as a matter of law. To avoid summary judgment, the other party must make a sufficient showing of a material dispute as to an essential element of the case, meaning that the case must proceed to trial on the facts.

Recent cases primarily involved requests for summary judgment. Even though most of the decisions were to return the cases for trial, they are valuable for their discussions of the standards the courts use to determine liability.

Burden of Proof

As a side note, practitioners should be aware that all of the cases decided in the past year dealt with penalties assessed prior to July 22, 1998, the enactment date of the Internal Revenue Service Restructuring and Reform Act of 1998. Does the shift in the burden of proof provided for under Sec. 7491 apply to TFRP cases? While that question is beyond the scope of this item, it is instructive that one district court touched on the issue. In Hudson, DC Pa. (1999), the judge wrote, "with respect to assessments made prior to July 22, 1998, such as those here relevant, there is a rebuttable presumption in favor of the correctness of the assessment." This is one area that practitioners should watch.

Determining Responsibility

There is no uniform national standard used to determine responsibility. There are, however, elements that are common to all of the Federal appellate court decisions. No single element of any of the standards is recognized as being so important that its presence is enough to establish liability, or that its absence is enough to defeat liability. Instead, the courts tend to look at how many of the elements are present. This is important to know if a Revenue Officer tells the practitioner that a client is going to be held responsible, merely because he is a a corporate officer or signs checks.

Different courts of appeals have enumerated various lists of factors by which to judge responsibility. Practitioners should pay attention to these, particularly those within their own circuits. This will allow them to better structure their clients' individual situations to avoid potential future liability.

Factors to Be Considered

These are the factors, by circuit, which were cited by various cases in 1999. (Note the striking similarities.)

Second Circuit. Courts generally take a broad view of who qualifies as a responsible person. The core question is "whether the individual has significant control over the enterprise's finances."

For "significant control," the court considers whether a person:

1. Is an officer or member of the board of directors;

2. Owns shares or possesses an entrepreneurial stake in the company;

3. Is active in the management of day-to-day affairs of the company;

4. Has the ability to hire and fire employees;

5. Makes decisions regarding which, when and in what order outstanding debts or taxes will be paid;

6. Exercises control over daily bank accounts and disbursement records; and

7. Has check-signing authority. See Hochstein, 900 F2d 543 (2nd Cir. 1990), and Fiataruolo, 8 F3d 930 (2nd Cir. 1993), quoted in Tarlow, DC NY (1999).

Third Circuit. "A responsible person is one with significant control over the company's finances. This control need not be exclusive, so long as it is significant ... It is thus insufficient to defeat liability that another person has more control, or even has the final word, over the finances of the company. Courts in this circuit have considered the following factors in the analysis of section 6672 responsibility as well ...":

1. Officer's duties as outlined by the corporate by-laws;

2. Individual's ability to sign corporate checks;

3. Taxpayer's signature on the employer's Federal employment or other tax returns;

4. Identity of the corporate officers, directors and shareholders;

5. Identity of the individuals who hired and fired employees; and

6. Identity of the individual(s) who was in charge of the corporation's financial affairs.

See Hudson, quoting Carrigan, 31 F3d 130 (3rd Cir. 1994).

Second and Fifth Circuits, cited by Fourth Circuit. The Fourth Circuit undertook a pragmatic, substance-over-form inquiry into whether an officer or employee "`participated in decisions concerning payment of creditors and disbursement of funds' that he effectively had the authority--and hence a duty--to ensure payment of the corporation's payroll taxes."

The court said that indicia of actual authority or ability to pay the taxes owed (in view of an employee's status within a corporation) include whether the employee:

1. Served as an officer of the company or as a member of its board of directors;

2. Controlled the company's payroll;

3. Determined which creditors to pay and when to pay them;

4. Participated in the day-to-day management of the corporation;

5. Possessed the power to write checks; and

6. Had the ability to hire and fire employees.

See Plett, 185 F3d 216 (1999), citing O'Connor, Landau, 155 F3d 93 (2nd Cir. 1998) and Barnett, 988 F2d 1449 (5th Cir. 1993).

Fifth Circuit. Factors to consider in determining a responsible person are whether that person:

1. Is an officer or member of the board of directors;

2. Owns a substantial amount of stock in the company;

3. Manages the day-to-day operations of the business;

4. Has the authority to hire or fire employees;

5. Makes decisions as to the disbursement of funds and payment of creditors; and

6. Possesses the authority to sign company checks.

See Barnett, cited in Logal, 195 F3d 229 (5th Cir. 1999).

Seventh Circuit. To be responsible, the court considered whether the person:

1. Had an entrepreneurial stake in the company;

2. Was a corporate office;

3. Had authority to disburse funds on the company's behalf;

4. Had the ability to take out loans on the company's behalf; and

5. Had the ability to hire and fire employees.

See Charlton, 2 F3d 237 (7th Cir. 1993), cited in Johnson, DC Ill (1999).

Ninth Circuit. "Factors to consider when determining whether an individual is a `responsible person' are whether the individual ...":

1. Is an owner, an officer, or a director of the corporation;

2. Manages the day-to-day operations of the corporation;

3. Makes decisions as to the disbursement of funds and payment of creditors;

4. Has check-signing authority;

5. Has authority to sign corporate tax returns; and

6. Can hire and fire employees.

See Alsheskie, 31 F3d 837 (9th Cir. 1994), cited in Larson, DCWa (2000).

Eleventh Circuit. Indicia of a responsible person include:

1. Holding a corporate office;

2. Controling financial matters;

3. Having authority to disburse corporate funds;

4. Owning stock in the company; and

5. Having authority to hire and fire employees.

See George, 819 F2d 1008 (11th Cir.), cited in Harris, 175 F3d 1318 (1999).

While these lists of factors vary from circuit to circuit, certain factors are common to all. The ability to hire and fire employees, the authority to disburse funds (as distinguished from the authorization to sign checks) and the holding of a corporate office are viewed by all of the circuits above as important indicators of liability for the TFRP. No factor, however, is ever considered determinative on its own.

Conclusion

What does this mean to a person who is involved with a corporation not paying its payroll taxes? A person who has apparent (but not actual) authority is at-risk for a TFRP assessment. Courts have looked to documentation as a means of establishing actual authority, according to the facts and circumstances of each case. Corporate bylaws, written directions as to what obligations and taxes are to be paid, memoranda of conversations, internal e-mails and meeting minutes can all be used to help establish who exercised authority that would hold that person liable. It is clear that the courts look beyond mere appearances and consider the actual operation of a corporation when determining liability. Any evidence that sheds light on how a corporation makes decisions furthers the goal of properly and fairly assessing the TFRP.

FROM HARRIETT A. JACOBS, CPA, MST, MICHAEL SILVER & CO., SKOKIE, IL AND JOHN C, DOMKE, MSIR, SKOKIE, IL