Who is a "responsible person"?

Honorary positions on charitable executive boards and figurehead positions as chief executive officer or president are quite a distinction and often highly valued by those appointed, but danger exists if the company or organization fails to pay its payroll taxes. If the IRS determines that the individual is a "responsible person," not only is he or she liable for the deficient taxes, but may also be required to pay a penalty. Two recent district court cases illustrate how this might apply in situations in which clients might feel they have little (if any) exposure for such tax.

Background

Sec. 6672 states that the IRS must prove both responsibility and willfulness before it can hold a person liable for unpaid payroll taxes. Responsibility means whether or not the individual had the power and opportunity to pay the taxes; willfulness is established when the person responsible neglects to pay the taxes. Once responsibility is established, the burden falls oil the individual to disprove willfulness, even if nonpayment was not intentional.

Marino

Facts: In 1995, Daniel Myers asked James Kunkle, son of Ellen Marino, to incorporate SUSA/U.S. Financial, Inc. (SUSA), a licensed correspondence mortgage lender. Myers could not serve as an officer of the corporation due to his past credit problems. Thus, Myers asked Marino to become president, sole shareholder and mortgage lender license holder for SUSA and gave her the power to write checks on the corporation's behalf. Despite her position, Marino had little contact with the business or its employees and took no active role in the corporation's daily operations. Marino also allowed Myers to use a corporate stamp with a facsimile of Marino's signature on company checks, in lieu of Marino's actual signature. Myers ran the corporation's day-to day affairs from its inception until it ceased operations.

In 1999, IRS letters began to arrive at Marino's house, requesting information on the nonpayment of SUSA'S payroll taxes. After being alerted that SUSA was having tax problems, Marino received assurances from Myers that he and the company accountant would address the problem. In 2000, the IRS served Marino with a summons, as it had not received the requisite information, and began levy SUSA's accounts to pay for the liability.

Bankruptcy court's decision: Eventually, SUSA and Marino filed for bankruptcy. The bankruptcy court determined that Marino was not personally liable for SUSA's payroll taxes; she was not a responsible person, because she lacked authority or power over company management, did not control its financial operations and did not hire or fire employees. In essence, she was a figurehead. The court determined that she willfully neglected payment of the taxes, because she knew of the deficiency and did not ensure it was paid. Even though she willfully neglected to pay, Marino was held not personally liable, because she was not responsible. The IRS immediately appealed the decision.

District court's decision: On appeal (In Re: Ellen L. Marino, MD FL, 5/12/04), the district court disagreed with the bankruptcy court's conclusion that Marino was not a responsible person for payroll tax purposes. It ruled that while Marino clearly did not involve herself in the company's day-to-day operations, nothing precluded her from doing so. Because she was the president and sole shareholder, she had the opportunity to take control of the company at ally time if she sensed Myers was acting incorrectly and could have ordered trim to pay the taxes when the deficiency became known. Also, because she had the power to sign corporate checks, she could have paid the taxes herself, out of company funds. Once the district court determined that Marino was responsible, it then bad to decide whether she was will fill ill not paying the payroll taxes.

To determine willfulness, the court looked at two different time periods. The initial period consisted of the first two quarters of 1999, the time before the IRS sent letters to Marino stating the tax was not being paid; the second period consisted of the last quarter of 1999 and the first quarter of 2000. The court determined Marino showed reckless disregard during the first period, because she knew the company was having financial problems. During this time, Marino contributed money to the company and helped secure additional financing with a lending institution. The court reasoned she should have known the possibility existed that the company was not paying its payroll taxes.

For the second period, the court determined that Marino committed willful disregard because she knew of the deficiency after receipt of the letters, and should have followed up with Myers and/or the accountant, regardless of their assurances. Unfortunately for Marino, her reckless disregard during the first time period and her willful disregard during the second time period established willfulness for Sec. 6672 purposes. The district court reversed the bankruptcy court's decision and entered judgment for the IRS; Marino was held personally liable for the payroll taxes and associated penalties.

Holmes

Michael Holmes initially served as a director and eventually was promoted to chairman of the board of Harvest Christian Academy; both positions were unpaid. Due to financial difficulties, the school became insolvent ill 1998. The board paid some creditors and decided to settle with others. During this time, the board's only goal was to keep the school open as long as possible. Holmes, Fred Floyd (another director) and the school administrator were the signatories for the school's checks, which required two signatures. Holmes claimed he rarely signed checks and usually only in the absence of one of the other two signatories.

While the school was undergoing financial hardship, Holmes was notified by Floyd (also the school treasurer), that the school was not remitting its payroll taxes. Holmes presented ideas to the board in an attempt to pay the taxes, but claimed it rejected his ideas. In 2001, the IRS assessed Holmes and Floyd jointly for the liability. Each contested it; the IRS counterclaimed that both men were jointly liable under Federal law. The district court found Floyd liable for his portion of the payroll taxes.

District court's decision: When the district court heard Holmes' case (Michael E. Holmes, SD TX, 5/7/04), it had to determine whether Holmes was a responsible person who willfully evaded the payment of taxes. The court ruled he had responsibility; as board chairman, he could have ordered the taxes paid or co-signed checks authorizing the payments. The court also determined he acted willfully, because he knew of the tax liability, had participated in discussions as to payment of creditors (including the IRS) and chose not to pay the delinquency. At one point, Holmes signed returns showing the school made no payroll tax deposits for an entire quarter.

The taxpayer argued he could not be held responsible, because he had made an effort to pay the taxes. He argued he presented ideas to the board, but it chose to ignore him. The court disagreed, saying Holmes could have protested or overridden its decision in his capacity as chairman and a co-signer of the checks. Holmes also contended that because he was not the only signer, he was not responsible; two people were needed to complete the transaction. The court determined that the need for multiple signatories showed only that multiple people were in control, as evidenced by the judgment already levied against Floyd.

The district court held for the IRS; Holmes was required to pay his portion of the delinquent taxes and associated penalties.

Conclusion

Ellen Marino and Michael Holmes were two individuals attempting to help others. They performed their duties to the fullest extent deemed necessary, and yet were held liable when others around them failed. These cases are indeed distressing, but a valuable lesson emerges. If a client is offered a position in an organization (charitable or otherwise), he or she should find out exactly how much authority he or she will have over the entity's operations and financial decisionmaking, even if he or she chooses not to exercise it. Not knowing or misunderstanding could lead to unanticipated consequences.

FROM ERIC PILCHER, AIDMAN, PISER & COMPANY, P.A., TAMPA, FL