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Avoiding the 100% penalty.

Avoiding the 100% Penalty

For the businessman and his accountant, banker and attorney, the 100% penalty under Section 6672 of the Internal Revenue Code(1) can be a terrifying prospect if a business goes sour. Under Section 6672, a "responsible person" with the duty of collecting, accounting for or paying certain employment and excise taxes to the IRS will be held personally responsible for the taxes not remitted. If there is more than one responsible person, each will be held liable for the entire amount. The IRS can only collect the unpaid taxes once, however. Although criminal liability is also possible in egregious cases, this article will deal with the more common civil penalty.

Which Taxes?

The taxes at issue are the employees' share of FICA (Social Security) taxes, withheld income taxes, railroad retirement taxes, collected excise taxes and withheld tax on nonresident aliens, foreign corporations and foreign partners. Once the employer or collector files a return with the IRS, the government generally has three years from the filing of the return to assess the penalty. After the penalty is assessed, the IRS must collect it within 10 years unless it files suit and obtains a judgment. If no return is filed, the penalty can be assessed at any time.

How Liability Arises

Typically, a business will experience cash flow problems and pay employees, suppliers and other creditors while ignoring the IRS. Unfortunately, while bankruptcy may be the cure for ordinary commercial debts, it will not prevent the IRS from assessing the 100% penalty against any or all of the persons deemed responsible for the nonpayment of the taxes. For these persons, personal bankruptcy is no help either, as the responsible persons can include individuals, trusts, estates, associations, partnerships, companies and corporations.

Once the IRS determines that the taxes are delinquent and its collection notices have failed, the matter will be assigned to a revenue officer in the district where the business is located. The revenue officer will obtain from the state secretary of state a listing of a corporation's officers and interview them, either voluntarily or by a summons. The revenue officer will complete a Form 4180 (Report of Interview Held with Persons Relative to Recommendation of 100% Penalty Assessments) and ask the following key questions:

1. What title did you hold with the corporation? 2. What were your duties? 3. What non-officers had authority over the company's finances? 4. Did anyone discuss the nonpayment of taxes? When? 5. What other bills were paid while the taxes were owing? 6. Who had check-signing authority? 7. Did anyone provide the corporation with funds to pay payroll without paying the taxes?

The Chosen Ones

The most important thing to remember about Section 6672 is that it is a tax collection device. Thus, the revenue officer will prefer to go where there is money available. This is how the banker, financial consultant, lawyer or accountant for the business can land in trouble.

A useful rule of thumb in assessing 100% penalty cases is to look at the check signers and those who had the power to sign checks for the corporation. These will be the easiest targets for the IRS, because the argument will be that if other creditors were being paid, the non-payment of taxes by the check signer must have been willful, a requirement under the statute.

In the case of a closely-held corporation where the president is also the sole shareholder, the 100% penalty will be difficult to avoid. In such cases, if the business is operating, the corporation can voluntarily designate that tax payments be directed first to trust fund taxes, for which the president would be personally liable, by including a restrictive endorsement on the back of the check stating: "To be directed for payment of trust fund taxes of XYZ Corporation." The same type of allocation can be done in a Chapter 11 bankruptcy, if approved by the court.

Even silent investors can be held liable for the unpaid taxes if they had the power to determine which creditors would be paid. Thus, the passive or nominee investor may be in for a rude awakening if the business falters. Even if there are more responsible persons, the IRS approach is to assess the penalty against everyone who meets their criteria and let them fight the assessments.

Similarly, a company accountant or controller who was only following orders in writing the firm's checks will be held liable even if the employee faced being fired if he or she paid the taxes first. Even the outside accountant is not immune. In Quattrone Accountants, Inc. v. Internal Revenue Service,(2) an accounting firm was a responsible person because it kept a client's books and paid the client's bills without needing prior approval of the company's board of directors.

Similarly, in United States v. Vaccarella,(3) a court held that an asset-based lender was liable for its client's unpaid taxes because the lender directly funded the company's payroll accounts and chose to pay other creditors over the IRS.

Dangers for Professionals

As the above cases indicate, professional advisers are not immune from their clients' tax problems. Accountants, attorneys or planners should avoid accepting a title or director position with a client's corporation unless they are prepared to stay advised of the company's finances. There is a fine line between wanting to make certain that the client makes proper business decisions and stepping into the client's operations. Once the adviser crosses the line, he or she becomes a possible IRS target, because the willfulness requirement of the 100% penalty covers recklessness, or knowing that taxes are owing, but not doing anything about it.

Has Anyone Avoided the Penalty?

In those cases in which a seemingly responsible person has avoided liability, another party was blamed. There is always at least one responsible person, even if it is an outsider. The key to a successful defense is finding the correct party. For example, a church treasurer avoided liability by finding four witnesses to testify that the chairman of the deacon board made the preliminary and final decisions as to which bills to pay. The treasurer merely followed orders.(4) Similarly, a company president avoided liability where he successfully claimed that the chief financial officer determined which bills to pay.(5)

In another recent case(6), the Claims Court held that a doctor was not a responsible person even though he was the sole shareholder, officer and director of his professional corporation. His argument? The doctor prevailed by testifying that his firm administrator had final authority over which bills to pay, including taxes. The doctor was too busy practicing medicine to be concerned about unpaid employment taxes. It is important to note, however, that this decision may not be followed by other courts as other cases have held that a responsible person, such as a company president with check-signing authority, may not delegate away the responsibility to pay employment taxes.(7)

The common theme in the above cases is that regardless of the person's corporate title and ability to sign checks, they lacked the power to determine which creditors to pay. As the true nature of someone's power in a corporation is elusive, the successful practitioner will interview for the record as many of the possible responsible persons and their co-workers, suppliers and creditors as possible in order to obtain evidence that the client is not to blame for the unpaid taxes.


The 100% penalty under Section 6672 is a potent tool for the IRS because it permits the government to recoup unpaid taxes from a failed business. The key to avoiding liability is to know the IRS' criteria for assessing the penalty and being able to present a plausible, well-documented case for shifting the blame to another person or entity if the IRS raises the issue.


(1)26 U.S.C. [Subsection] 6672 (2)895 F.2d 921 (3d Cir. 1990) (3)735 F.Supp. 1421 (S.D.Ind. 1990) (4)In re Triplett, 115 Bankr. 955 (1990) (5)In re Premo, 116 Bankr. 515 (1990) (6)Stewart v. United States, 19 Cl.Ct. 1 (1989) (7)Schultz v. United States, 19 Cl.Ct. 280; Cassidento v. United States, 90-1 U.S.T.C. (CCH) p. 50,171 (D.Conn. 1990)

Harry Charles, CPA, is an attorney with the St. Louis office of Bryan, Cave, McPheeters & McRoberts. He practices in the areas of federal, state and local tax controversies. He received his MBA from Washington University and his law degree from the University of Illinois.
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Title Annotation:penalty on failure to remit taxes; Section 6672 of the Internal Revenue Code
Author:Charles, Harry
Publication:The National Public Accountant
Date:Jun 1, 1991
Previous Article:Postretirement benefits other than pensions.
Next Article:Looking good: IRS takes steps to improve service.

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